$135b still frozen by an early ’08 debacle
As they grapple with the credit crunch, many businesses across the country have yet another cash constraint: more than $100 billion tied up in a part of the bond market that shut down last February and that isn’t going to reopen.
Vicor Corp. is one of them. The Andover maker of power systems for electronics invested $38 million in so-called auction-rate securities, a type of bond that everyone used to think was ultra-safe. Now it won’t see that money again until at least 2010.
James A. Simms, Vicor’s chief financial officer, said the publicly traded company, which employs 1,000 people, is fortunate it doesn’t need the cash to fund daily operations, but it’s still a hassle.
“Roughly half our cash is tied up in illiquid investments,” Simms said. “It is a nagging anxiety. It’s always in the background.”
The investment firms that marketed these bonds sold them as cash-like equivalents. But the market collapse means Vicor and others cannot sell the bonds and get their money back, some $135 billion in trapped funds, according to Capital Advisors Group Inc. of Newton. Among the companies with money trapped are Tufts Health Care of Watertown and Five Star Quality Care Inc., a Newton owner of residences for senior citizens.
I’m glad I pulled all my investments out.
In a year of bewildering financial scandals, from the implosion of the mortgage market to Bernard L. Madoff’s alleged Ponzi scheme, the auction-rate securities debacle was one of the first big failures. Regulators have not untangled the mess, though they have forced the Wall Street giants that ran the auction-rate market to buy back more than $60 billion, mostly from individuals, nonprofits, and small businesses.
But large companies still have billions of dollars in bonds frozen, and they’re not likely to get their money back for at least two years. Meanwhile, the US government has spent billions bailing out troubled banks, insurers, and carmakers – adding to the companies’ frustration.
The $330 billion auction-rate securities market collapsed on Feb. 13 after every Wall Street firm stopped trading the bonds, saying demand for them had dried up. With credit short in numerous debt markets, the banks were not willing to prop up the auctions by purchasing the bonds themselves. That left thousands of investors – individuals, nonprofits, and businesses – trapped, unable to engage in the one basic thing US markets always promise: the orderly trading of securities.
The collapse also hurt the issuers of these bonds, who had become accustomed to this cheap form of borrowing: municipalities, student lenders, hospitals, museums, and other nonprofits.
In retrospect, the shutdown of the auction-rate market offered a warning of the chaos to come – before the collapse of Bear Stearns, Lehman Brothers, Fannie Mae, and Freddie Mac. The auction-rate mess offered a glimpse of just how much caution Wall Street had thrown to the wind, and how unaware regulators were of the brewing trouble that would bring the financial system to its knees.
“When we make money, the same reward circuitry [in the brain] gets stimulated as when you’re on cocaine,” said Andrew W. Lo, a professor of finance at MIT’s Sloan School and director of its Laboratory for Financial Engineering. “This explains Madoff. It explains the rapid growth of securitization, the subprime mortgage market, and the auction-rate securities market.”
There were, in fact, warnings about the dangers of these securities, from investment advisers and major accounting firms.
Auction-rate securities had boomed once before, in the 1980s. They were invented by a former Lehman Brothers investment banker, Ronald Gallatin, in 1984 and widely used by American Airlines, Chase Manhattan, Sarah Lee, and other companies, including savings-and-loan institutions. By the late 1980s, after having attracted billions of dollars, some of the auctions failed, forcing the companies to redeem their debt.
Joseph S. Fichera of Saber Partners, a New York investment adviser that specializes in municipal finance, has long warned about the pitfalls of auction-rate securities. “It never was an auction,” he said. “It ultimately collapsed under its own weight.”
In effect, brokerage firms were looking for new investors to buy out the old ones, he said, even after they knew the market was in trouble. By the time they all stopped trading, the veneer of safety – AAA ratings on the underlying debt – had vanished. Investors were trapped holding debt that paid decent returns, but debt they could not sell if they wanted their money back.
Now the still-trapped investors find their quandary has been eclipsed by the dramatic events of the last few months.
By the time Congress held hearings on the freeze in the auction-rate market, in September, Wall Street was burning, and key legislators such as US Representative Barney Frank, a Massachusetts Democrat who is chairman of the House Committee on Financial Services, seemed relieved that many financial firms had stepped up with settlements. There was a sense the worst was over. Tell that to the legions of investors and companies stuck holding auction-rate securities in closed-end investment funds or in securities related to student loans.
Five Star Quality Care, a publicly traded senior living-services provider, has nearly $75 million tied up, leaving it with just $39 million in available cash at the end of the third quarter. The company last month said it would take a loan from UBS against those securities, for now.
And when might it get its money back? Between 2010 and 2012.
“It’s a huge inconvenience,” said Bruce J. Mackey Jr., Five Star’s chief executive.
By Beth Healy