Here's a couple of quick notes on the auction rate market. First, it is truly amazing to me that there are so many people that call themselves market professionals claiming to have never heard of this market. It's been around for a long time. I remember back in the late Eighties when my bonus got dinged because of a truly "failed" auction (the issuer filed Chapter XI). Back then, the dealer-manager of these things had to eat the failure. Second, other than the Port Authority, who is really upset about being "stuck" accepting a 20% tax-free yield? Put it in perspective, that's almost +1700 to Libor. Are the buyers really concerned about the Port Authority going bankrupt? Are they only willing to accept 20% if it has a bond insurance wrapper? Do the buyers have all their liquidity tied up in this product? (if the answer to this one is yes, then that is their mistake, especially in this environment). I'm not a table pounder, but if someone wants to assign me their Port Authority auction product, send me an email and we'll discuss it.
This morning, Hank Paulson paraphrased me (probably not directly) regarding the pricing of risk. He said that risk had been underpriced and now it had probably swung back too far the other way. This is similar to the pendulum swinging too far one way and when it comes back, it swings far in the other direction. It is hard to describe, but if you weren't involved in it, you can't believe how far risk had been mispriced. I think a lot of that had to do with the concept, which unfortunately is still prevalent and valid on Wall Street, that it is possible to completely define and quantify all risks in some mathematical formula. My last observation in this piece it is a shame that this concept hasn't been supplanted everywhere (it does exist in a few places, look at the successful firms) with one that actually works and makes sense.
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2 comments:
Ok Bondguy, I will skip over the mispricing of risk because we both know how severely mispriced. Lets discuss how Auction Rate Securities were misunderstood.
Auction Rate Securities are marketed at most firms as money market securities, not even as money market alternatives. These are long-term (perpetual securities), what makes them money markets?
Since ARS have frequent auctions, they are (were) considered money market investements. Investors purchased ARS as a way of parking money for a short time. Though you and I would both take Port Authority ARS at 20%, what are investors who were counting on liquidating his or her ARS to meet a financial need. I wrote about this today in my IUO piece. I had one FA rip me for telling the truth about ARS. I will make mention on my own blog.
I have little sympathy for poor planning. As is increasing apparent to me, people don't know what they own. What is truly sad is that people that are paid to know this have no idea waht they are doing. Mr. French Fry and I were discussing are ARS (actually an ARP) bonus woes from the 80's earlier tonight.
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