What are Auction Rate Securities (ARS)
Auction Rate Securities, often called ARS, are long-term bonds or preferred stocks that behave like short-term cash. Their stated maturity can be 20 to 30 years, but the interest rate or dividend is reset in regular auctions. Those auctions were usually weekly, monthly, or every 35 days. The idea was simple. You own a long-term security, but you can sell it each auction period. That made ARS look like a cash alternative.
How the auctions work
Auctions set the interest rate or dividend for the next period. Investors place bids that say the minimum yield they will accept. The auction then matches supply and demand.
Main steps:
- Issuer offers a block of securities for auction.
- Investors and broker-dealers submit bids.
- Bids are ranked and accepted until supply is filled.
- The clearing rate is set and applies until the next auction.
If enough buy bids exist, the auction clears and holders can sell at the new rate. Some broker-dealers also placed support bids to make sure auctions cleared.
Types of ARS
Common types include:
- Municipal ARS. Issued by cities, states, or agencies.
- Corporate ARS. Issued by companies as preferred stock or debt.
- Closed-end fund ARS. Shares tied to auction resets.
Related but different products:
- VRDOs (Variable Rate Demand Obligations). These have a liquidity backstop from a bank that lets investors demand liquidity outside the auction. That makes them safer than plain ARS.
The main benefits people were sold
- Higher yields than money market funds.
- Short-term liquidity because of regular auctions.
- Low credit risk when issued by governments or big institutions, at least on paper.
These claims made ARS popular with institutions and wealthy individuals before 2008.
The risks
ARS carry risks that were easy to miss.
Liquidity risk
- If buyers dry up, auctions fail and you cannot sell when expected.
- In a failed auction you remain stuck until a later auction clears or a buyer appears.
Market risk
- If interest rates rise, the value of the long-term underlying security can fall.
Auction risk
- Auctions can fail if demand is weak or dealers stop supporting them.
Conflict of interest
- Some brokers placed support bids for their own inventory. That hid real market demand. When dealers stopped supporting auctions, problems surfaced.
Counterparty risk
- The issuer or a liquidity bank could default.
Regulatory and legal risk
- After the 2008 freeze, many investors sued or accepted buyback settlements from brokers.
The 2008 ARS freeze
In February 2008 the market for ARS largely froze. Major broker-dealers stopped providing support bids. Many auctions failed. Investors could not sell their holdings, sometimes for months. Regulators later found that brokers had misled clients about liquidity and the safety of ARS. Large settlements followed. Many brokers agreed to buy back ARS from retail clients at par.
How to identify ARS on your statements
Look for these clues:
- Name includes "auction rate", "auction", or "ARS".
- Maturity listed as decades long while interest rate resets monthly or weekly.
- Line items showing a variable rate but long final maturity.
You can also call your broker and ask for the prospectus or offering document.
If you hold ARS now
Options depend on your situation.
Check settlement offers
- After 2008, some firms still honor buybacks or settlements for certain accounts. Ask your broker.
Hold to maturity
- If you can wait and the issuer is creditworthy, you may receive principal and interest over time.
Sell in secondary market
- There is still a reduced secondary market. Expect to sell at a discount.
Seek advice
- If large sums or if you suspect mis-selling, talk to a fee-only financial advisor or securities attorney.
How to avoid ARS problems in the future
- Understand liquidity before buying. Ask what happens if an auction fails.
- Prefer instruments with explicit liquidity backstops like VRDOs.
- Avoid products you cannot price easily or sell quickly.
- Ask for the prospectus and read the liquidity and auction risk sections.
Quick FAQ
What is a failed auction?
- When not enough buy bids come in and the auction does not clear. Holders cannot sell at that auction.
Are ARS safe?
- Safety depends on liquidity and the issuer. Credit may be fine but liquidity can vanish.
Did brokers fix auctions?
- Some broker-dealers placed support bids, which helped auctions clear. Regulators later found conflicts of interest in how ARS were sold.
Where can I get help?
- Contact your broker first. If you suspect mis-selling, contact the securities regulator in your country and consider legal advice.
Bottom line
Auction Rate Securities looked like cash but carried hidden liquidity risk. The 2008 freeze exposed that risk and left many investors stuck. If you still hold ARS, check settlement options, confirm issuer credit, and decide whether to hold until maturity or seek a sale at market price. Learn from this market: always ask how you will get your money back before you buy any investment.