The collapse of the roughly $330 billion auction-rate securities market this year was fueled by a lack of transparency and may have been avoided if investors had a comprehensive source for disclosures that showed the extent to which successful auctions were dependent on broker-dealer intervention, the Securities and Exchange Commission's municipal securities chief said yesterday.
Martha Mahan Haines said that one of the biggest problem in the ARS market was its opacity, which may have kept investors from knowing that a small group of broker-dealer firms that bid on the auctions were critical to preventing widespread failures. Even though broker-dealers disclosed that they were bidding on auctions, the extent of their participation was unknown, she said.
"If investors could see that broker-dealers were so active in this market ... perhaps it wouldn't have grown so large, well beyond the broker-dealers' ability to hold it up," Haines said, speaking at the Securities Industry and Financial Markets Association's legal and compliance conference in New York. "We may not have gotten into this mess had there been transparency."
Haines' remarks come as the Municipal Securities Rulemaking Board is considering establishing a centralized system for the collection and dissemination of critical market information about both auction-rate securities and variable-rate debt obligations, which are considered short-term securities.
Haines' remarks were echoed by John Cross 3d, an attorney with the Treasury Department's office of tax policy, who said that there is a lack of basic information about auction-rate securities that likely confused many investors.
At a fundamental level, he said, market participants did not understand the difference between auction-rate securities - which have no liquidity facilities but were nonetheless widely considered highly liquid, short-term investments - and money-market eligible VRDOs, which have liquidity facilities and are thus eligible for investment by money market funds under the SEC's Rule 2A-7.
Liquidity facilities include lines of credit, standby bond purchase agreements, or other arrangements in which an entity, typically a bank, promises to purchase securities that cannot be immediately sold or remarketed to new investors. Demand for ARS was fueled at least in part by the fact that they were cheaper than VRDOs, which usually include pricey letters of credit, he said.
"One of the biggest, broadest themes right now is basically efforts to dress up auction-rate securities so that they have liquidity facilities so that they can be sold to the money market funds," Cross said, referring to the push by issuers to convert their ARS to VRDOs or fixed-rate bonds. "That unfortunately comes at a time when the financial positions and balance sheets of all the banks are equally challenged and the silver bullet of adding liquidity facilities ... still faces ongoing business challenges."
In February, investors stopped buying ARS following ratings downgrades of bond insurers that backed them and the auctions held to periodically reset the rates began to fail when they did not attract enough buyers.
In the past, banks and broker-dealers put in bids of their own for these securities to prevent auctions from failing. But in June 2006, 15 firms agreed to pay $13 million to settle charges that they violated the securities laws by not disclosing these and other auction-rate securities practices. Some firms began disclosing their practice of putting in bids to prevent auctions from failing. But the credit crunch led banks and dealers to tighten their lending standards and in February, they stopped bidding on auctions.
Meanwhile, Haines said yesterday she expected that the commission would soon propose changes to its Rule 15c2-12 on disclosure that would designate the MSRB's Electronic Municipal Market Access, or EMMA, system, as the central repository for secondary market disclosures.
The long-anticipated rule change would replace the four existing nationally recognized municipal securities information repositories with EMMA. Previously, SEC chairman Christopher Cox has said that the proposed rule change would come out in May, but Haines said yesterday that the delay is attributable to the care with which the proposal is being crafted.
"The commission staff has taken the internal view that it's better to do it slow and to do it right the first time than to get something out fast that's not right and that you have to go back and fix," she said.