Auction Rate Securities Dealers Ask Treasury for Liquidity Facility under Emergency Economic Stabilization Act
As the financial crisis deepens, auction rate securities dealers have asked the Treasury to offer a standby liquidity facility to issuers of such securities, for which the issuers would pay a commitment fee. The dealers maintain that Treasury has the authority to do this under the Emergency Economic Stabilization Act. The auction rate securities market has been frozen for the past eight months, leaving retail investors with long-term bonds that they couldn’t sell.
The dealers group told Treasury that the market collapsed despite the fact that the credit quality of most auction rate securities has not deteriorated significantly. According to the dealers, problems in the auction rate securities market are principally related to illiquidity, deleveraging and dysfunction in the broader financial markets, and not to credit deterioration related to these products specifically.
In the letter to Treasury, the Regional Bond Dealers Association said that the Act authorizes Treasury to take actions that could significantly improve conditions for auction rate securities and could help avoid a circumstance where liquidity constrained banks are forced to buy a large volume of illiquid securities. Specifically, the association cited Section 101 of the Act, which authorizes Treasury to purchase, and to make and fund commitments to purchase, troubled assets; and Section 102, which requires Treasury to establish a program to guarantee troubled assets originated or issued prior to March 14, 2008.
The dealers group believes that either of these authorities, but especially the authority provided in Section 101, allows the establishment of a program under which Treasury would offer the equivalent of standby bond purchase agreements for variable rate demand notes issuers whose liquidity facilities are expiring and for auction rate securities issuers who want to convert their securities to variable rate demand notes to restore liquidity to investors.
Under the program proposed by the association, Treasury would offer a standby liquidity facility to issuers of auction rate securities originally sold before March 14, 2008 secured by whatever assets are currently supporting outstanding auction rate securities. Issuers would pay a commitment fee, in today’s market this fee is typically 0.45 to 0.55 percent, for the facility.
The issuers would exchange new variable rate demand notes backed by the liquidity facilities for outstanding auction rate securities. The association expects that many of the new demand notes would be eligible for investment by money market mutual funds subject to regulation under SEC Rule 2a-7. In the view of the dealers, these actions would open up a new source of demand for issuers whose auction rate securities are generally not currently eligible for investment by these funds.
The dealers group believes that safe, stable variable rate securities supported by a Treasury liquidity facility would appeal to a broad range of investors. It is unlikely that the facility provided by Treasury would be drawn on to a significant extent, said the group, because its mere existence would likely provide confidence to investors and restore normalcy to the market for the affected products.
If it did buy assets under the program, Treasury would earn interest at maximum penalty rates that would likely exceed its own cost of funds and would, in that regard, have a positive carry. In any case, Treasury would earn revenue from commitment fees. More broadly, the proposed liquidity would help an orderly market emerge for hundreds of billions of dollars of assets frozen on the balance sheets of banks, broker-dealers and investors.