Previous Columns
8:30 AM EST Monday, March 10, 2008: There are six important developments on auction rate preferreds (ARPs) since Friday's column:

First, the broad extent of personal anguish is becoming apparent. Already people have walked from the deposits they put down on houses because the earmarked monies due at closing were tied up in illiquid ARPs. There are taxes that won't be paid on April 15. Personal bankruptcy is now looming for honest, thrifty people -- many of whom are also afraid of losing their house to the IRS because of the taxes they owe, but now can't pay. There are thousands of people whose life savings are tied up in ARPs and are now scared for their retirement. There are kids and grandkids who won't go to college because their college fees are tied up in ARPs. There are charities whose good work is coming to a grinding halt because the money to pay doctors and nurses is locked up in ARPs. I don't make this stuff up. I have emails and phone calls.

Second, one fund (the first) -- Aberdeen Global Income Fund -- has announced that it is redeeming its outstanding ARPs for cash. The fund is doing this though it is not obliged legally to redeem the shares. It is doing this because it feels morally obliged. Its executives told me that it had not marketed its ARPs as a long-term security. "This is not the way the way we marketed these securities. When we marketed these shares, we never intended that the preferred (the ARPs) would be illiquid." Aberdeen's move is a huge breakthrough. It puts pressure on all the bigger issuers of these things -- Nuveen, Eaton Vance, BlackRock, etc. -- who have been dilly-dallying around saying they're "working well into the night" but leaving their ARPs holders high, dry and illiquid. For more on what Aberdeen did, see Friday's column and a Bloomberg story.

Third, the legal industry (if we can call it that) is gearing up for massive lawsuits against Wall Street -- brokers, banks and issuers. There's potentially far more money at stake here than there ever was for asbestos. The market for auction rate securities is $360 billion. These lawsuits, if successful, could easily bankrupt vast areas of Wall Street. I believe the lawsuits have a good shot at being successful. Virtually every broker or bank who sold auction rate securities lied to their clients about the risks, more precisely, the lack of risk. Many brokers and banks simply disregarded their clients' instructions as to what securities the clients wanted, and dumped the clients into these things. Virtually all ARPs were sold in violation of Wall Street's own rules -- about providing prospectuses to clients, etc. Most brokers and banks are guilty of being ultra-lazy and not researching even in the smallest way the risks associated with auction rate securities. A simple Google search two months ago (before this disaster happened) would have turned up warning after warning on the riskiness of auction rate securities. Several research papers freely available on the Internet laid out the scenario that ultimately happened. I hate to see lawyers getting super-rich on the backs of poor people's life savings, but there are sufficient desperate people out there ready to sign up to class action suits -- and, in the process, sign away a third of their life savings.

Fourth, I have no idea what this will do to Wall Street's reputation. Wall Street is not Apple. It doesn't sell an iPod whose quality and design you can hear, see and feel. Wall Street sells trust. I can't imagine any of the thousands and thousands of people whose money is tied up forever in ARPs to ever do one penny's worth of business with Wall Street ever again. I hear that business for many brokers has already dropped off dramatically. And I suspect that some of the decline in recent weeks in stock prices is due to the fact that people (like me) simply can't get to their money and can't buy any shares -- no matter how "cheap" they look.

Fifth, some brokers are stepping up to the plate and redeeming their clients ARPs. I have a reader who owned $100,000 of ARPs. He complained to his broker, who agreed that owning them was not what the client (or he, the broker) had wanted. And the broker personally stepped up to the plate and used his own money (not his firm's) to buy half his clients' ARPs. The broker paid $50,000. The cash appeared a day or two later in his client's checking account -- much to his client's relief.

Sixth, the mainstream financial press has woken up and is beginning to cover the ARPs crisis. The press needs more help from you and me. We need to call the financial editor of our local newspaper, the reporters on the 6 PM news and every other reporter you can find and tell them in clear English what Wall Street has just done to your savings, your kids' education, your upcoming tax payments, your chances of buying a new house, etc. I ask you to stand up. Tell them your story. How much money you have locked up, how it happened, the name of the broker who put you into these things -- without warnings, without prospectuses and despite your strict instructions that you wanted safety and liquidity for your money. That you wanted a place to park your money temporarily.

I don't know how this will play out. But I suspect that the Federal Government and agencies of it will have to get involved. And for this to happen we need the support of our Senators, Congresspeople, local Governors, local Attorneys-General and the Federal Reserve. The faster they get the message, the better. You may reference today's column and previous columns. And you can email me -- -- and I'll help you as much as I am able. I am not interested in taking your money. I am not a lawyer. I have two interests -- getting my own $4.5 million out of illiquid Nuveen ARPs into cash and helping my long-term readers, who may also be stuck in these horrid things.

It is your obligation as an ARPs owner to apply pressure. I believe it's too early for lawyers. I believe there's a lot we can do as concerned citizens. (See below.)

I want you to read an article by one of America's leading and best financial reporters, Gretchen Morgenson, of the New York Times. This was published in yesterday's newspaper.

As Good as Cash, Until It’s Not
INVESTORS across the nation are finding themselves in Wall Street’s version of the Hotel California: they have checked into an investment they can never leave.

The investments, which Wall Street peddled as a cash equivalent, are known as auction-rate notes. They’re debt instruments carrying rates that reset regularly, usually every week, after auctions overseen by the brokerage firms that originally sold them. They have long-term maturities or, in fact, no maturity dates at all.

But because the notes routinely traded hands at auctions, Wall Street convinced investors that they were just as good as cold, hard cash.

Lo and behold, the $330 billion market for auction-rate notes ground to a halt in mid-February when bids for the securities disappeared. Investors who thought they could sell their holdings easily are now stuck with them. It turns out that the only thing that’s really just as good as cash is, well, cash.

While investors pray for a resurrection in the auction market, they are receiving a fixed interest rate outlined in offering documents. Historically, these securities have paid approximately one percentage point more than money market funds. Many purchasers of these notes are relatively small individual investors; several years ago, banks dropped the minimum investment in them to $25,000 from $250,000.

Municipalities and other tax-exempt institutions have issued most of the current crop of auction-rate notes. But closed-end mutual funds issued $65 billion worth. Such borrowings provide leverage to the funds, letting them generate slightly higher yields for their common stockholders.

Closed-end funds that issue auction-rate notes typically sell them in amounts worth one-third the value of their underlying assets. For example, the John Hancock Tax-Advantaged Dividend Income fund, with $1.17 billion in assets, has issued $380 million in auction-rate notes.

Owners of notes issued by closed-end funds are faring far worse than investors stuck with municipal issues. That’s because the interest rates paid on municipal notes when auctions fail are capped at as much as 12 percent, much higher than the caps on closed-end fund notes, which are currently around 3.25 percent.

In other words, holders of closed-end fund notes receive little to no premium for being stranded. Even airlines try to give you a free meal or an upgrade when they leave you at the gate. Investors are likely to remain in this vise because closed-end fund issuers have no incentive to redeem their notes since the interest rates resulting from the failed auctions are so low.

Some customers who have tried to get their brokers to cash them out say the firms have responded by offering to let them borrow against the value of these securities. At a cost, of course: the typical margin rate for borrowers is at least 7 percent at most shops. Other holders are selling the notes at a deep discount to speculators willing to buy distressed securities.

Wall Street made generous fees issuing these securities and running the auctions — as long as there were bidders. After the bidders vanished, some firms stepped in and bid for the securities for a while, giving investors a way out.

No more. What’s the sense stretching your already-thin balance sheet just to keep a market open for your customers?

In interviews, investors who own these securities say they weren’t warned that they might not be able to sell them if an auction failed. They say they were told that the instruments were as safe and liquid as — yes, you guessed it — cash.

Stephen N. Joffe, a client of UBS Financial Services, is suing the firm because it put all $1.35 million of his charitable foundation’s cash into auction-rate securities issued by Eaton Vance Limited Duration funds. This, even though he said he explicitly told the broker to take no risk and that he would need constant access to the funds.

Dr. Joffe, 65, is a former professor of surgery who founded LCA-Vision Inc., a company that operates laser vision-correction centers. “I never asked my broker to get me a better rate,” he said. “I felt the responsibility to maintain this account as a risk-free account. I believed this was in the equivalent of an overnight money market account.”

Now, the Joffe Foundation can no longer fund programs that help prevent AIDS in Africa, provide indigent people with laser vision correction and correct the cleft palates of African children.

“This was another hit and run by Wall Street,” said Jacob H. Zamansky, a lawyer in New York who represents Mr. Joffe. “The banks reaped huge fees on the auctions and underwriting, then left investors holding the bag.”

UBS declined to comment.

IN recent days, executives at several closed-end funds have held conference calls with stricken investors. But the investors say that none of those funds have offered to redeem their auction-rate notes. That’s not surprising: their fee structures give them no incentive to buy out investors.

Unlike no-load mutual funds, closed-end funds are sold, not bought. They often decline to prices that are a discount from their net asset values after they are first offered for sale. One reason for the discount is that it reflects the brokers’ commissions.

But Arthur D. Lipson, an investor in distressed securities and a principal at Western Investment LLC, argues that these discounts present an opportunity for closed-end funds to do the right thing, for both common and preferred shareholders.

Here is Mr. Lipson’s solution: Because these funds trade at discounts, he suggests that their managers sell underlying securities — utility stocks and shares of real estate investment trusts — and use the proceeds to buy back common shares. This would shrink the size of the funds and allow them to redeem some of the preferred shares they issued to increase the fund’s yield.

Managers hate this idea, Mr. Lipson said, because it would severely reduce the management fees they receive, based on the assets in the funds. So he has mounted proxy fights at three funds, seeking board representation to try to force them to follow his prescription.

The three funds are John Hancock Tax-Advantaged Dividend Income, which trades at around 7.5 percent less than its net asset value; the Cohen & Steers REIT and Utility Income fund, trading at a 10.5 percent discount; and Cohen & Steers Select Utility, which carries a 5 percent discount.

“The directors of these funds have ignored their responsibilities to the shareholders and have chosen to protect the managers’ fee income,” Mr. Lipson said. “These are not operating companies where moms and pops would be out of work. They are merely financial engineering companies.”

Officials at the funds contend that Mr. Lipson is a speculator out for a fast buck. They urge shareholders to vote against him, saying that they have taken steps to improve fund performance.

As for the frozen market for auction-rate notes, both fund companies say they are working with regulators on a solution.

The annual meeting for shareholders in the John Hancock fund is scheduled for March 31; shareholders in the two Cohen & Steers funds will vote on Mr. Lipson’s dissident slate the next day.

That is about the time that investors will receive their first brokerage statements reflecting major declines in the value of auction-rate notes. It certainly would be a happy ending to this mess if closed-end funds were forced to redeem the notes by selling holdings as Mr. Lipson suggests.

Stay tuned.

There are probably 50 ways that the funds could cash out your and my ARPs. Lipson's approach is various called "deleveraging." Now back to Aberdeen. Executives of Aberdeen Global Income Fund told me on Friday that they had borrowed the exact money from a bank that would be necessary to pay off all its ARPs owners -- a total of $30 million. This was not deleveraging. There was not selling of any bonds. They simply swapped the ARPs owners for a bank loan. Hence the capital structure of the fund stayed the same. Same leverage. Same profits for the common shareholders. The fund is FCO.

I have received many emails and phone calls detailing how awful this whole mess is and how it's seriously affecting people's lives. One phone call:

I have the Nuveen Real Estate Fund. It was sold by Wachovia Bank as an extremely safe thing, no risk, seven day money, available any time. The broker didn't disclose any of the risk factors to me whatsoever. It's my life savings for my kids for college. I'm totally lost without it. It's extremely scary for me.

Here's an email I received. Reading these emails is heartbreaking.

Harry,

I stumbled upon your site while researching the mess I am in with ARP's. I was to close on my first home purchase next week, but had to fall out of escrow and lose a $15,000 deposit as I have $150,000 frozen in Nuveen Auction Rate Preferred. The seller, agent, and loan officer all think I am making this up, but I only wish I was.

These are the taxable preferred. I have asked Mr. Hurd to find alternative financing for the leverage in the CEF. On the conference call they spoke of problems issuing new taxable debt to leverage the muni CEF, but in the taxable CEF this should be not problem.

From what you have researched, how long do you think we will be holding these? Could it be to perpetuity?

Wells Fargo Capital Markets is setting up a secondary market, but they are already seeing indications at 50% discounts.

I can't sleep, eat, work, as I worry about my life savings being permanently in ice.

Thanks for listening and putting up info on your site.

The Face-Slap Theory

Friday’s employment report — which was so weak that it had many economists declaring that we’re already in a recession — was bad news. But it was actually less disturbing than what’s going on in the financial markets.

The scariest thing I’ve read recently is a speech given last week by Tim Geithner, the president of the Federal Reserve Bank of New York. Mr. Geithner came as close as a Fed official can to saying that we’re in the midst of a financial meltdown.

To understand the gravity of the situation, you have to know what the Fed did last summer, and again last fall.

As late as August the favorite buzzword of financial officials was “contained”: problems in subprime mortgages, we were assured, wouldn’t spread to other financial markets or to the economy as a whole.

Soon afterward, however, a full-fledged financial panic began. Investors pulled hundreds of billions of dollars out of asset-backed commercial paper, a little-known but important market that has taken over a lot of the work banks used to do. This de facto bank run sent shock waves through the financial system.

The Fed responded by rushing money to banks, and markets partially calmed down, for a little while. But by December the panic was back.

Again, the Fed responded by rushing money to banks, this time via a new arrangement called the Term Auction Facility. Again the markets calmed down, for a while.

But again, the respite was only temporary. Last month another market you’ve never heard of, the $300 billion market for auction-rate securities (don’t ask), suffered the equivalent of a bank run. Last week two big financial companies announced that they had been unable to raise the cash demanded by their lenders. Even Fannie Mae and Freddie Mac, the giant government-sponsored mortgage agencies long regarded as safe places to put your money, are now having trouble attracting funds.

One consequence of the crisis is that while the Fed has been cutting the interest rate it controls — the so-called Fed funds rate — the rates that matter most directly to the economy, including rates on mortgages and corporate bonds, have been rising. And that’s sure to worsen the economic downturn.

What’s going on? Mr. Geithner described a vicious circle in which banks and other market players who took on too much risk are all trying to get out of unsafe investments at the same time, causing “significant collateral damage to market functioning.”

A report released last Friday by JPMorgan Chase was even blunter. It described what’s happening as a “systemic margin call,” in which the whole financial system is facing demands to come up with cash it doesn’t have. (A financial joke making the rounds, via the blog Calculated Risk: “Who is this guy Margin that keeps calling me?”)

The Fed’s latest plan to break this vicious circle is — as the financial Web site interfluidity.com cruelly but accurately describes it — to turn itself into Wall Street’s pawnbroker. Banks that might have raised cash by selling assets will be encouraged, instead, to borrow money from the Fed, using the assets as collateral. In a worst-case scenario, the Federal Reserve would find itself owning around $200 billion worth of mortgage-backed securities.

Some observers worry that the Fed is taking over the banks’ financial risk. But what worries me more is that the move seems trivial compared with the size of the problem: $200 billion may sound like a lot of money, but when you compare it with the size of the markets that are melting down — there are $11 trillion in U.S. mortgages outstanding — it’s a drop in the bucket.

The only way the Fed’s action could work is through the slap-in-the-face effect: by creating a pause in the selling frenzy, the Fed could give hysterical markets a chance to regain their sense of perspective. And to be fair, that has worked in the past.

But slap-in-the-face only works if the market’s problems are mainly a matter of psychology. And given that the Fed has already slapped the market in the face twice, only to see the financial crisis come roaring back, that’s hard to believe.

The third time could be the charm. But I doubt it. Soon, we’ll probably have to do something real about reducing the risks investors face.

A plan to restore the credibility of municipal bond insurance would be a start (how crazy is it that New York State, rather than the federal government, is taking the lead here?). I also suspect that the feds will have to get explicit about guaranteeing the debt of Fannie and Freddie, which really are too big to fail.

Nobody wants to put taxpayers on the hook for the financial industry’s follies; we can all hope that, in the end, a bailout won’t be necessary. But hope is not a plan.

More information on ARPs. There is much information in Friday's column, some of which I don't want to repeat. Here's a little reading that came in over the weekend.

+ Closed-End Funds. Is there light at the end of the Tunnel? -- from Wachovia Securities. Click here.

+ Allianz Global Investors Fund Management Provides an Update on Auction Rate Preferred Shares issued by its Closed-End Funds. Click here.

+ Lawyers, Auctions and Money from the SVB Financial Group. Click here.

+ Application of MSRB rules to transactions in Auction Rate Securities from the Municipal Securities Ratemaking Board. Click here.

+ Closed-end Fund Update. Failed APS Auctions. Impact on Closed-End Funds. Click here.

+ I have added some more executives below.

I repeat: If you own failed auction rate preferred securities (ARPS), please send me an email. We need to talk. There are serious benefits in combining our thinking. . I am not a law firm. I am not a financial advisory firm. I am not seeking fees, I am stuck in these things, just like you. I am seeking collective wisdom.

Failed auctions reading:
+ Auction Bond Failures Near 70%; No Sign of Abating (Update2). From Bloomberg.com. By Michael McDonald. Click here.

+ Allianz Global Investors Fund Management Provides an Update on Auction Rate Preferred Shares issued by its Closed-End Funds. Click here.

+ Nuveen eyes auction-rate options, offers no timeline. Dow Jones Newswires. By Daisy Maxey. Click here.

+ No Answers Yet To a Trillion-Dollar Question, Wall Street Journal March 5, 2008, page D3 by James B. Stewart. Click here.

+ Risks of a 'Safe' Investment Are Found Out the Hard Way. Wall Street Journal. February 27, 2008; page D4 by James B. Stewart. Click here.

+ The reality of the Failed Auction Market. Capital Advisors Group. Click here.

+ Calamos releases comment on auction rate securities market. Click here.

+ Frozen Liquid: More Auction-rate Securities Put on Ice. SBA Communications becomes the latest company stung by auction-rate securities when its inability to liquidate them forces it to take a $15.6 million impairment charge. From CFO.com. By Tim Reason. Click here.

+ Another Kick in the ARS. As troubles continue in the auction rate securities market, Massachusetts's securities regulator begins probing financial firms for information. From CFO.com by Tim Reason. Click here.

+ Nuveen Squeezed as Auction Failures Rise; OppenheimerFunds Buys. From Bloomberg.com. By Jeremy R. Cooke and Adam L. Cataldo. Click here.

+ No Mark of ARS? Bristol-Myers Replaces Its CFO. Drugmaker says the change doesn't reflect its recent $275M charge. It selects Royal Numico finance chief Huet to succeed Bonfield. From CFO.com. By Stephen Taub and Roy Harris. Click here.

+ Replay of Eaton Vance conference call. 1-800-642-1687. Access code 37152796.

People to write to and to express your anger: We are adding more names each day. Send your favorite villains.

+ Nuveen is owned by Madison Dearborn. Tim Hurd is Madison Dearborn's partner in charge of their Nuveen investment. (They paid $5.75 billion for Nuveen.) His email address is Thurd@mdcp.com. His phone number is (312) 895-1170.

+ Eaton Vance chairman and CEO, Thomas E. Faust, Jr. His email is tfaust@eatonvance.com. His phone number is 800-225-6265 ext 8201. His executive assistant is Kelly Creedon. His address is Eaton Vance, 255 State Street, Boston, MA 02109.

+ The closed end fund top dog at BlackRock is Brian D'anna. He's on Linkedin. Also CEO - Laurence Fink - Laurence.fink@blackrock.com
and CFO - Paul Audet - paul.audet@blackrock.com

+ Van Kampen CEO - Michael Kiley. COO - Ed Wood - ed.wood@vankampen.com. Jack Reynoldson - Executive Director, Fixed Income Investments - 630-684-6325; All these other employees can be found by asking the Operator to be connected to their office - Operator # is 630-684-6325 Steven Massoni - Managing Director Unit Investment Trusts; Andrew Scherer - Managing Director Investment Platforms; David Linton - Managing Director National Sales and Howard Tiffen - Managing Director Senior Loan.

+ BlackRock. Robert Kapito, President - robert.kapito@blackrock.com; Scott Amero - CIO Fixed Income - scott.amero@blackrock.com;
Robert Doll - CIO Equity - robert.connolly@blackrock.com ; Bennett Golub - Managing Director and Head of Risk and Quantitative Analysis - bennett.golub@blackrock.com

If you have more names, send them. These people need to understand the misery they have inflicted on countless thousands of innocent people. They need to understand that their businesses depend on our trust. Right now they have lost our trust. The longer they delay finding a solution, the less we will ever trust them. That includes the brokers and the issuers.

Irish Entrance Exam. It's harder than it looks. Don't sneak a peak at the answers below.

Tillie, Maude and Gertrude
Three old ladies were sitting on a park bench having a quiet conversation when a flasher approached from across the park.

The flasher came up to the ladies, stood right in front of them and opened his trench coat.

Gertrude immediately had a stroke.

Then Maude also had a stroke.

But Tillie, being older and more feeble, couldn't reach that far.

A final note: I wrote this column starting at 3:00 AM California time this morning. If some of the hyperlinks don't work, send me an email. My eyes don't work well at 4:00 AM.

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 is . You can't click on my email address. You have to re-type it . This protects me from software scanning the Internet for email addresses to spam. I have no role in choosing the Google ads on this site. Thus I cannot endorse, though some look interesting. If you click on a link, Google may send me money. Please note I'm not suggesting you do. That money, if there is any, may help pay Michael's business school tuition. Read more about Google AdSense, click here and here.
Go back.