The NYTimes reported yesterday on a kind of investment called ‘auction securities’ which were apparently dumped on individual clients by institutional investors in the second half of 2007. 

“Auction-rate securities, invented in the 1980s, are debt obligations whose interest rates are set at auctions every 7 to 35 days. The bonds typically have maturities of 30 years, but the preferred shares have no maturity date. ”

“The market worked relatively smoothly until mid-February this year, when the credit crisis made big brokerage firms reluctant to put up precious capital to keep the auctions going. Investors could no longer sell their securities — and cannot to this day.”

“Indeed, experts say that calling these securities auction-oriented is something of a misnomer because real auctions — during which buyers and sellers meet and an interest rate is set based upon their interest — weren’t taking place in recent years. Instead, the Wall Street firms in charge of the auctions smoothed the process by bidding with their own capital rather than rustling up thousands of buyers to meet up with sellers every week or so. ”

Because firms are receiving their fees regardless of whether the auctions succeed or fail, there is apparently no incentive for them to act to revive the market.  This means that investors, stranded by a managed bidding system, could have their principle tied up for an indefinite period of time…

For the full article see here.