20091009 Auction-Rate Debacle

NY Times, Oct. 09, 2009
Law Obscures the Facts of the Auction-Rate Debacle

Auction-Rate Securities

Company issue such securities, borrowing money from the securities buyer, and pay interest to the buyer. It is supposed that the securities is easy to sell at it's face value in the market, so that some brokers just see it as money equivalent.

As such securities often have no maturity, it is seen as long-term capital at balance sheet of the issuer. But because the interest rate reset every week, by the holder sell the securities through a Dutch auction (the interest rate drops until someone buy it), the interest rate is short-term.

If the securities can't be sold, issuer has to pay penalty interest. But issuer or financial organization eventually reduce the penalty interest to very low, even to zero.(This information maybe not revealed clearly.) When the auction-rate market collapses, securities with high penalty interest may redeem by the issuer. But for those with low penalty interest, they may be never redeemed by the issuer.

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