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Coalition Wants ARS Liquidity

WASHINGTON — A coalition of publicly traded, non-bank corporations that own billions of dollars of illiquid student loan auction-rate securities is pushing for a federal liquidity backstop so they can sell the ARS and have money to invest in their businesses.

The group generated a lot of media publicity earlier this fall when it released an academic report arguing there would be immense economic benefits if the federal government were to help provide liquidity at par to institutional investors that held illiquid student-loan ARS.

The coalition's study estimated that every $1 billion of liquidity restored to the student loan ARS market would result in a minimum of 15,000 jobs and a total stimulus of at least $2.3 billion. Were the government to provide liquidity to the roughly $25 billion of illiquid student loan ARS still held by these institutions, it would translate into $63 billion of stimulus and 441,000 jobs, the group said.

Though the numbers were eye popping, they didn't immediately resonate with market participants, nor among lawmakers on Capitol Hill, where the coalition's ideas for a Treasury-financed liquidity backstop were shopped.

At least one former banker said the numbers in the study were incoherent and that the coalition's hope for liquidity at or near 100 cents on the dollar is akin to a homeowner trying to sell his property at inflated 2006 home prices.

Meanwhile, lawmakers were said to be unsympathetic to the coalition's arguments on the grounds that it was more important for the government to assist individuals rather than sophisticated corporations. ARS settlements reached with the Securities and Exchange Commission and other regulators generally required firms to provide liquidity at par to retail as well as nonprofit investors and required them to pledge their "best efforts" at providing liquidity to institutional investors, or those with more than $10 million in investments.

But the coalition is pushing back on several rhetorical fronts, arguing that some form of federal intervention is needed more now than ever.

Erik Klingenberg, a partner at Sonnenschein Nath & Rosenthal LLP in New York who is working with the coalition, said it has been nearly two years since the ARS market collapsed in February 2008, yet a private solution for providing liquidity at par to institutional investors has not materialized.

"If some banks want to step up and start buying these securities out at par, that'd be great, but at the moment it doesn't seem like that's happening," he said. "Whether there's the possibility of a private solution is less the point [than] that it has not materialized."

SLARS, unlike other classes of securities, are clearly not going to improve through normal markets, he added, noting that since the government is already backing 97% of the credit on the loan underlying the securities, it would not be unreasonable — or expensive — for the government to extend liquidity support to an asset class it already guarantees.

Further, at the end of the year, deadlines begin to expire for firms to commit their best efforts at providing liquidity to institutional investors under settlements with the SEC and other regulators, after which there will be no systemic solution to the illiquidity problems, he said.

Of the "best efforts" that firms must make to institutional investors, John Woodfill, the vice president of finance at Ash Grove Cement Co., said: "It's [supposed to be] best efforts, but as far as we can tell, there hasn't been much effort." Though the firm now owns about $140 million of ARS split evenly between SLARs and auction-rate preferred stock — down from about $300 million at the time of the market's collapse — it has turned down redemption offers because they were far below par, he said.

Asked about these concerns, SEC officials said they are monitoring the firms' progress and will analyze their efforts at the end of the "best efforts" periods. If best efforts were not undertaken, the commission could go to court and seek civil penalties, they said.

Market participants note that liquidity is being restored, albeit slowly, to the $70 billion illiquid student loan ARS market. For instance, there is a burgeoning market through online sites like Second Market that trade illiquid securities such as ARS at prices below par.

Meanwhile, Brazos Student Finance Corp. yesterday provided only vague preliminary results of an exchange offer involving about $500 million of senior and subordinate ARS that remain outstanding from 2004. It appeared from the company's press release that most of the participants of the exchange were underwriters rather than investors.

Asked about such exchange offers, Klingenberg said they generally reflect "very ad hoc or individual transactions," and fall short of a systemic solution being sought by the coalition.

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