Opinion ID: 799254
Heading Depth: 2
Heading Rank: 2

Heading: 2008 Collapse of the ARS Market

Text: Historically, ARS auctions rarely failed, and the ARS market was a relatively safe and liquid market. Beginning in the second half of 2007, however, ARS auctions began to fail. In a November 2007 email, the head of Morgan Keegan's short-term products desk commented, We are in a credit crunch & it will get worse before it gets better . . . Wall Street can't carry anymore [ARS] paper. In early February 2008, auctions failed at increasing rates, restricting the ability of investors to liquidate their ARS and access their funds. This increased auction failure resulted from most ARS underwriters, other than Morgan Keegan, ceasing to place supporting bids. On February 8, 2008, the first auction co-brokered by Morgan Keegan failed. In an email sent that day, Frank Phillips, Morgan Keegan's head of retail trading, stated that Morgan Keegan had suspended all buying of ARS from dealers other than Morgan Keegan. On February 9, 2008, Phillips sent an email to Kevin Giddis, the head of Morgan Keegan's retail fixed income trading desk, expressing concern about ARS auction failures and brokers' misunderstandings of ARS: The [ARS auction] fail[ures] have potential to kill consumer confidence and could cause a panic to sell based on fear of losing liquidity. If this scenario of yelling fire in a crow[ded] room plays out, then other types of auction rate securities will begin to fail and I fear, will show that a lot of brokers have misrepresented [the] product to their clients. Being that I trade the auction rates, I know a lot of brokers do not understand the product fully and do not know what a failed auction means. If the broker doesn't understand what a failed auction is, do you think the customer does? Unfortunately, I don't think so. By February 12, 2008, there were approximately 100 failures in auctions in which Morgan Keegan played some participating role (although not as lead manager). On February 13, 2008, many major ARS underwriters stopped supporting auctions, and auctions failed on a widespread basis. On February 15, 2008, Giddis sent Morgan Keegan's brokers an email titled AUCTION-RATE UPDATE-PLEASE READ. The email included an attachment describing the state of the ARS market and states, Share the information with your customer but please don't send out. Marked for internal use only, the attachment describes the ARS market issues as liquidity-driven rather than credit-driven, and includes background information about what happens when an auction fails. In a section titled Advice to Investors and Financial Advisors, the attachment states that the credit quality of the auction rate market remains strong and that no investor has lost principal on a deal in which Morgan Keegan was involved. The attachment further advises brokers to avoid the impulse to sell their customers' ARS: We stress the importance of ignoring the impulse to test the process by selling your clients' ARS holdings in a wholesale manner simply because you or your clients might be worried you will not be able to sell them; we maintain our commitment to supporting the ARS market to the extent possible, but this is only possible with your cooperation. Remember, your clients are being well-compensated for holding their ARS positions and the liquidity concerns should eventually sort themselves out. Morgan Keegan continued to support auctions by buying ARS for its own account and thereby provided liquidity for its ARS customers. As a result, Morgan Keegan's ARS inventory increased from $18 million to $54 million by February 8, 2008, to $133 million by February 15, 2008, to $179 million by February 21, 2008. On February 22, 2008, Giddis again emailed Morgan Keegan's brokers and noted that some auctions were still succeeding and that none of the auctions for which Morgan Keegan was the lead manager had failed. On February 27, 2008, Morgan Keegan elected to cap its ARS inventory at $182 to 185 million. After reaching the inventory cap, Morgan Keegan stopped purchasing ARS for its own account. On February 28, 2008, the first Morgan Keegan-managed auction failed. As a result of the 2008 market collapse, Morgan Keegan's ARS customers could not sell their securities through the auction process or liquidate their investments. [1] In the end and as of March 20, 2008, Morgan Keegan's customers were left holding approximately $2.2 billion of ARS, including approximately $1.1 billion of ARS underwritten by Morgan Keegan. [2]