Today’s NY Times has a clearly written article describing what’s really going on with Auction Rate Securities titled It’s a Long, Cold, Cashless Siege. There’s a lot of confusion going around about what ARS are and how they work so it’s nice to finally see "the simple stories" appearing. If you are curious about how these things really work or if you are interested in another straightforward story, Fred Wilson has one of the best first person accounts up on his blog titled Our Run In With Auction Rates And What It Taught Me About Markets.
When the auctions first started failing a few months ago, a close friend mentioned to me that he had most of his liquid cash tied up in ARS. For him, it was a good news / bad news story as he needed access to the cash, but was able to borrow against it at a much lower interest rate that his ARS reset to (in almost all cases, if the auctions fail, the interest rates get reset higher – sometimes much higher.) So – while he’s now borrowing against his own money (er … ok) he’s at least making some points on the spread.
I hadn’t ever heard of ARS so I sent a note to the firm that manages my bond portfolio and asked "do we have any ARS." It turns out that we only had one – a Denver International Airport bond that reset to an interest rate 150% higher than it was previously paying. The amount of cash tied up didn’t impact me so I was / am perfectly happy to get the higher interest rate while the bond is illiquid.
A couple of days later I got a note from Silicon Valley Bank – where a number of our portfolio companies bank – announcing that they don’t have any auction rate security exposure with any of their clients. It hadn’t occurred to me that our portfolio companies might have any of their money tied up with ARS since our default investment policy for portfolio companies is "keep your money in 100% liquid things like money market and treasuries." So I sent out a note to a couple of banks to check. Simultaneously, I heard from one of our companies (not one that I was on the board of) that they did have a bunch of their money in ARS’s. This prompted me to dig in a little deeper, especially with that particular bank.
Since most of the companies I’m on the board of bank at either SVB or Square 1, my investigation was easy. Square 1 – like SVB – has no ARS exposure so all of those companies were fine. I had one company that banked at the same place that our other portfolio company did (which it turns out – had half of their cash tied up in an ARS – unbeknownst to them since the bank has provided it as part of the "as safe as cash" investment opportunities.) A couple of days and several emails and a phone call later, I determined that (a) the company I was on the board of had no exposure, and (b) the bank was trying hard to convince people that there was no issue, yet they were doing it by dodging the direct question until you asked them verbally.
In the middle of all of this, a TechCrunch article came out titled 20% Of Valley Startups Can’t Get To Their Cash. While this alarmed me at first, it didn’t tie with the results of my investigation into our portfolio. Either my companies are all brilliant at cash management (unlikely), I’m incredibly lucky (possibly), or most of our companies bank with folks that didn’t get tangled up in ARSs (true – SVB and Square 1.)
My personal cash in the ARS is still in it (the auction hasn’t restarted) and I’m happily getting 150% of the interest payment I was getting before. The bond doesn’t come due until 2010 (and I usually hold individual bonds through to maturity) so check back in a couple of years to see if this has worked its way through the system.