Sacramento Auction Rate Securities

Sacramento auction rate securities (ARS) are long-term bonds which can act like short-term debts. With interest rates that are reset at auction every 7, 28, or 35 days, auction rate bonds were popular with borrowers and investors alike – until the $300 billion market collapsed in February 2008.

Auction rate securities broker-dealers reacted to the falling credit ratings of bond insurers by pulling out of the ARS market in early February. Without broker-dealers to act as bidders of last resort, hundreds of auction, unable to reach a clearing rate, failed within weeks. As the market tumbled, Sacramento investors discovered that they were unable to sell their holdings without successful auctions, leaving them trapped in a market that was once called ‘safe-as-cash’ by investment firms.

Factors behind the Sacramento Auction Rate Securities Crisis

At the heart of the auction rate securities crisis is the issue of liquidity. Liquidity, in finance, is a measure of how easily an asset or investment can be converted into cash; in other words, a measure of how quickly and efficiently that asset can be sold. Investors value liquidity for the safety and flexibility it gives them. Putting money into an illiquid asset is a risky commitment that many investors are unwilling to make.

While the Sacramento auction rate securities market was hot, investment firms aggressively encouraged clients to buy into it. They assured investors that ARS stocks and bonds were safe, liquid investments with a return higher than most money market instruments. What they failed to mention was that the liquidity of auction rate securities was artificial and dependent on a successful auction system. Because Sacramento auction rate bonds actually have very long maturity periods, they are made liquid only as long as they can be easily sold at auction. When the market soured in early 2008, this liquidity vanished, stranding thousands of investors across the nation.

Broker-Dealers and the Sacramento Auction Rate Securities Crash

Another fact about which many investors were ignorant was the role of broker-dealers in the auction rate securities market. In addition to holding and running Sacramento ARS auctions, broker-dealers also participated in bidding. By acting in their own auctions, broker-dealers ensured that there were enough bids to cover all available shares, thus guaranteeing that a clearing rate could be reached. Historically, this practice was very successful; only a few dozen auctions failed over a course of several decades.

When broker-dealers abruptly ceased to bid at auction, the system collapsed. Hundreds of auctions failed in the first week alone, with more to follow in subsequent months. Eventually, the auction rate market became almost entirely inactive, though broker-dealers continued to pull in fees for running unsuccessful auctions.

With transactions stalled, investors have turned to other means to seek relief. Some have attempted to trade out through a secondary market, but have found their efforts thwarted by banks’ self-interest in preventing further losses. Others have begun putting together class-action litigation and arbitration claims against the investment firms whose deceptive strategies ensnared them in the first place. To defend your rights and interests, contact an auction rate securities fraud lawyer at 800.220.9341 today.