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Frozen Auction-Rate Bonds Cost U.S. $63.5 Billion, Study Says

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By: Dunstan McNichol | October 20, 2009

Oct. 21 (Bloomberg) -- The U.S. economy would get a $63.5 billion boost if businesses were able to free up their funds trapped in the auction-rate debt market based on student loans, a study prepared for holders of the securities shows.

Businesses haven’t had access to about $25 billion in the auction-rate bonds since February 2008, when trading collapsed after the investment banks that managed the sales quit serving as buyers of last resort. Including student-loan securities held by banks, a total of $75 billion of the debt is outstanding, according to Mark Murphy, a spokesman for SecondMarket Inc., a New York-based clearinghouse for illiquid securities.

Cash from the government to restructure the auction-rate market would let businesses create as many as 441,000 jobs and begin expansion projects that have been delayed for lack of credit, according to the report by University of Delaware economics professors James Butkiewicz and William Latham.

“People need to consider the fact that reducing the access of these firms to these funds is producing more of a drag on the economy,” Butkiewicz said in a telephone interview before today’s release of the study. “If there’s some way to get this money unfrozen, that money’s going to be put to work doing things.”

Coalition’s Report

The report was commissioned by a coalition of about 25 nonbank holders of auction-rate securities that are pressing for federal funding to reopen the market. The coalition members hold a total of $8 billion in frozen student-loan auction-rate securities.

Members of the coalition include retailers Abercrombie & Fitch Co. of New Albany, Ohio, and Family Dollar Stores Inc. of Charlotte, North Carolina; technology companies Digital River Inc. of Eden Prairie, Minnesota, Texas Instruments Inc. of Dallas, Standard Microsystems Corp. of Hauppauge, New York, and Ariba Inc. of Sunnyvale, California; Duke Energy Corp. of Charlotte; Ash Grove Cement Co. of Overland Park, Kansas; and short-haul trucker Heartland Express Inc. of North Liberty, Iowa.

Auction-rate securities were designed to offer borrowers short-term interest rates on long-term bonds by putting the debt up for resale at auctions typically held daily, weekly or every 35 days. Investors believed they would have ready access to their holdings through the auctions.

The market collapsed last year when banks that had kept the auctions functioning by buying any securities that were not otherwise bid on stopped providing that support.

Negotiated Settlements

Since then, 26 banks involved in the sale of auction-rate bonds have negotiated settlements with state and federal regulators, paying $575 million in penalties and agreeing to buy back more than $61 billion of securities.

Texas Instruments in April sued New York-based Citigroup Inc., Morgan Stanley and BNY Capital Markets, now part of Bank of New York Mellon Corp., claiming the banks misled the company about the liquidity of auction-rate securities.

During the first quarter of 2008, Texas Instruments reclassified its $533 million portfolio of the securities as a long-term asset and reported losses of $41 million on the holdings as of June 30, according to regulatory filings.

Of 205 publicly traded companies that reported holding student-loan auction-rate securities, 96 percent had marked down their value by an average of about 12 percent, according to a study of regulatory filings by Pluris Valuation Advisors LLC, a New York firm that specializes in illiquid securities.