Will Auction Rate Securities (ARS) holders get their money back?

summarizes the likely fate of different classes of Auction Rate Securities (ARS) holders -- the $330 billion market for securities that used to reset in weekly auctions before it froze up in February. It reports that If you hold ARSs sold by a municipality or a taxable, closed-end mutual fund you may already have gotten your money back or may do so within weeks. And those holding issues from tax-free, closed-end municipal-bond funds will likely see some money back before long. But others may have a long wait ahead.

I first wrote about this in February and since then, the post has accumulated 4,031 comments. I cannot imagine how difficult it must be for these people to think they had their money in a safe, money-market like fund -- only to discover that they could not get access to their money at all. It appears that many of these ARS holders did not receive a prospectus and were not warned that the auctions could fail.

Meanwhile, here's Barron's prognosis for the different classes of ARS holders:

• Municipal Issuers. Issuers like cities and toll roads had about $165 billion of the ARS market. Bloomberg estimates that north of $63 billion of municipal ARS have been refinanced, and that ARS holders were bought out without losing any money. About half of the municipal auctions are working again, with interest rates in the 4% to 5% area.

• Taxable Closed-End Funds. These funds sell stock to the public and use the money to buy equities or taxable bonds. To boost returns, they sell auction-rate preferred stock (ARPS) or bonds and using the proceeds to buy more securities. At 2008's start, about $33 billion of auction-rate perpetual preferred stock was outstanding from Nuveen, Eaton Vance and BlackRock(NYSE: BLK). Regulators told the funds they couldn't help the ARPS holders at the expense of the equity holders. So a fund couldn't replace the preferreds with high-cost debt. Mariana Bush, a Wachovia Securities analyst estimates that 40% of ARSs sold by these funds "have been or will be" refinanced. That could rise to 80% in the next year.
• Municipal Closed-End Funds. Municipal closed-end funds buy municipal bonds and issue tax deductible dividends on their municipal closed-end fund ARPs. These funds have $28 billion of auction-rate preferred stock outstanding. Only $2 billion has been refinanced and the auctions are failing. Barron's guesses that the fund families and the government are motivated to find a solution, though it might take up to a year. But since these securities sell in the secondary market at only 82 cents on the dollar, with minimal credit risk, Barron's thinks it's worth waiting.
• Student Loans. $1 billion of the $85 billion outstanding student-loan-auction rate securities (SLARs) have been refinanced. Private companies have originated federally insured student loans and financed them by selling them into a trust. The trust in turn sells some medium- and long-term debt and some ARSs. As more auctions fail, a mechanism kicks in that prevents the average rate from going so high as to push a trust into default. As a result, some SLARs offer 0% rates to investors, but the rates tend to average 3% over time. This is not going to help solve the SLARs problem.
• Collateralized Debt Obligations (CDOs). Some CDOs -- securities made up of bundles of mortgage-backed securities -- bought fixed-income investments and financed them by selling ARSs. $20 billion of CDO ARSs are in failing auctions and illiquid. These ARSs won't be redeemed and will stay outstanding until the CDO winds down. Barron's thinks investors should push their brokers to find out what investments their CDO owns so they can decide what to do.

I don't know whether Barron's advice is any good. But years ago I met the author of this article, Jacqueline Doherty, and she seems very responsible to me.

Peter Cohan is President of Peter S. Cohan & Associates. He alsoteaches management at Babson College and edits The Cohan Letter . He has no financial interest in the securities mentioned.