Posted: 04/04/2008 01:00:00 AM MDT
Updated: 04/04/2008 03:37:02 AM MDT
Denver lawyer Jeffrey Cohen recently took $75,000 of his firm’s money to TD Ameritrade to hold in a money- market account.
He said a TD Ameritrade employee told him the money market wasn’t paying well so why not invest in auction-rate securities?
These are essentially long-term bonds that trade in weekly auctions. Brokerages have long been telling clients they are just as safe and liquid as the money markets, only they pay more.
Cohen was so pleased, he came back a few weeks later with another $25,000.
“I called the bond desk at TD Ameritrade,” Cohen said, “and the guy there said, ‘You can get in, but I’m not quite sure you can get out.’ I said, ‘What do you mean I can’t out?’ He said: ‘Yeah, you can’t get out. There are no more auctions. The auctions failed.’ ”
No auctions. No bond sales.
“It’s like the Roach Motel,” Cohen said. “Money can go in, but it can’t come out.”
Cohen isn’t alone. Moody’s Investors Service estimates that mutual funds, institutional investors and even a few little guys hold more than $300 billion in supposedly safe auction-rate securities, many of which are now frozen because nobody shows up for the auctions anymore.
Class-action lawsuits are flying. One filed this week claims Merrill Lynch “deceptively marketed (auction-rate securities) as cash alternatives to money-market funds.” Morgan Stanley and others face the same allegations.
William Loehman, a dog-kennel operator in Fort Collins, said his A.G.
Edwards/Wachovia Securities broker put $300,000 of his hard-earned money into securities backed by Missouri Higher Education Bonds.
“These securities were sold to me as a safe, liquid money-market alternative,” he said. “My wife and I are semiretired, self-employed people who depend on our investments for living income.”
Now Loehman is stuck, but if cash gets tight, he can get a loan.
“Wachovia Securities is working diligently on solutions to this industrywide problem, seeking to return liquidity to our clients as quickly as possible,” Wachovia spokesman Justin Gioia said. “As an interim solution, we are providing loans against clients’ securities to assist them in meeting immediate needs.”
A TD Ameritrade spokeswoman declined to comment.
On the other end of these failed auctions are municipalities and authorities — including Denver International Airport, Children’s Hospital, the CollegeInvest Student Loan program and the E-470 toll road. Unable to trade, they are now getting smacked with higher interest payments.
Many of the underlying assets of auction-rate securities are top- rated municipal and corporate bonds. They’re not supposed to go sour. But if nobody buys them, what are they worth?
What began as a few defaults in subprime loans has spread to a full-blown credit crunch.
The Federal Reserve Bank is giving emergency loans to investment banks but can’t bail out everybody.
What we learn in these desperate times is that many of the complex financial tools and markets that Wall Street creates are really just Roach Motels. But even Roach Motels can be useful.
Black Flag, maker of the Original Roach Motel, advises: “Roach Motel will tell you if you have a roach problem and how bad it is.”