Apparent Benefits of Auction Rate Securities
For issuers, ARS appeared to offer low financing cost, in some cases more attractive than traditional variable rate demand obligations (VRDOs). No third-party bank support was required, and there were typically fewer parties to the financing process. ARS eliminated renewal risk and the risk of increased fees. There was no exposure to bank rating downgrades, and ARS offered the same flexibility found in traditional VRDOs.
For buyers, ARS provided a slightly higher after tax yield than money market instruments due to their complexity with an increase in risk. Most securities were AAA rated as well as federal, state and local tax exempt. They also provided an opportunity to diversify one's cash equivalent holdings.
The collapse of the market in February 2008 revealed that these benefits were largely illusory. When market participants lost confidence, the auction mechanism failed. As a result, the ARS market has effectively ceased to exist.
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