Harry Newton's In Search of The Perfect Investment
Newton's In Search Of The Perfect Investment. Technology Investor.
8:30 AM EST Monday, March 10, 2008: There
are six important developments on auction rate preferreds (ARPs) since Friday's
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.
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
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"
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
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.
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 Its Not
INVESTORS across the nation are finding themselves in Wall Streets
version of the Hotel California: they have checked into an investment they
can never leave.
which Wall Street peddled as a cash equivalent, are known as auction-rate
notes. Theyre 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
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 thats really just as good as cash is, well, cash.
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
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.
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. Thats 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.
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.
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. Whats
the sense stretching your already-thin balance sheet just to keep a market
open for your customers?
investors who own these securities say they werent 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
Stephen N. Joffe,
a client of UBS Financial Services, is suing the firm because it put all $1.35
million of his charitable foundations 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.
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.
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. Thats not surprising: their fee structures
give them no incentive to buy out investors.
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
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.
Lipsons 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 funds yield.
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.
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.
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. Lipsons 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.
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.
boiling financial crisis: You
have to see all this within the broader framework of what's happening in the nation's
(and in the world) credit market. This may be the most serious crisis since the
Great Depression. I'm personally glad that for many months I've been preaching,
Cash is King. Paul Krugman is a professor of economics at Princeton. He
writes a regular column for the New York Times. This is today's column:
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
Thanks for listening and putting up info on your site.
employment report which was so weak that it had many economists declaring
that were already in a recession was bad news. But it was actually
less disturbing than whats going on in the financial markets.
thing Ive 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 were in the midst of a financial
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, wouldnt spread to other financial
markets or to the economy as a whole.
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 youve never heard
of, the $300 billion market for auction-rate securities (dont 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
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 thats sure to worsen the economic downturn.
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 whats happening
as a systemic margin call, in which the whole financial system
is facing demands to come up with cash it doesnt have. (A financial
joke making the rounds, via the blog Calculated Risk: Who is this guy
Margin that keeps calling me?)
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 Streets 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.
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 its a drop in the bucket.
The only way
the Feds 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.
only works if the markets 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, thats hard to believe.
The third time
could be the charm. But I doubt it. Soon, well 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.
to put taxpayers on the hook for the financial industrys follies; we
can all hope that, in the end, a bailout wont be necessary. But hope
is not a plan.
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
+ Closed-End Funds.
Is there light at the end of the Tunnel? -- from Wachovia Securities. Click
+ Allianz Global
Investors Fund Management Provides an Update on Auction Rate Preferred Shares
issued by its Closed-End Funds. Click
+ Lawyers, Auctions
and Money from the SVB Financial Group. Click
of MSRB rules to transactions in Auction Rate Securities from the Municipal
Securities Ratemaking Board. Click
+ Closed-end Fund
Update. Failed APS Auctions. Impact on Closed-End Funds.
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.
+ Auction Bond Failures Near 70%; No Sign of
Abating (Update2). From Bloomberg.com. By Michael McDonald. Click
+ Allianz Global
Investors Fund Management Provides an Update on Auction Rate Preferred Shares
issued by its Closed-End Funds. Click
+ Nuveen eyes
auction-rate options, offers no timeline. Dow Jones Newswires. By Daisy Maxey.
+ No Answers Yet
To a Trillion-Dollar Question, Wall Street Journal March 5, 2008, page D3 by
James B. Stewart. Click
+ Risks of a 'Safe'
Investment Are Found Out the Hard Way. Wall Street Journal. February 27, 2008;
page D4 by James B. Stewart. Click
+ The reality
of the Failed Auction Market. Capital Advisors Group. Click
+ Calamos releases
comment on auction rate securities market. Click
+ 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.
+ 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
+ Nuveen Squeezed
as Auction Failures Rise; OppenheimerFunds Buys. From Bloomberg.com. By Jeremy
R. Cooke and Adam L. Cataldo. Click
+ 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
+ Replay of Eaton
Vance conference call. 1-800-642-1687. Access code 37152796.
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 firstname.lastname@example.org.
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.email@example.com
and CFO - Paul Audet - firstname.lastname@example.org
+ Van Kampen CEO
- Michael Kiley. COO - Ed Wood - email@example.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 - firstname.lastname@example.org;
Scott Amero - CIO Fixed Income - email@example.com;
Robert Doll - CIO Equity - firstname.lastname@example.org
; Bennett Golub - Managing Director and Head of Risk and Quantitative Analysis
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.
Entrance Exam. It's harder than it looks. Don't sneak a peak at the
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.
had a stroke.
Then Maude also
had a stroke.
But Tillie, being
older and more feeble, couldn't reach that far.
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.