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Bad News for Holders of Auction Rate Securities Backed by Student Loans

As the landscape begins to clear for some holders of auction rate securities, for those holding $85 billion of such securities backed by student loans, the future is not so bright.

Student loan-backed auction rate bonds, sold as safe, liquid, cash equivalents, have been one of the worst performing segments of the market.  The problem is that the issuers of these student loan ARS have little or no ability to raise additional funds to redeem them.  Adding fuel to the fire is that the interest rates being paid on these ARS have fallen to zero.  The result, many investors are left holding positions that are illiquid and paying no interest.

Considering most of these investments were sold to investors seeking short-term growth with little risk and liquidity, the current prospects for the future are unacceptable. 

According to Aaron Pressman’s May 28, 2008 piece from BusinessWeek Online, while many municipalities have redeemed or are planning on redeeming the bonds they have issued, only one student loan issuer has announced a rescue plan.  The secondary markets are also failing to offer a solution for holders of these securities.

It is being reported that investors are likely to be stuck with as much as $70 billion worth of student loan-backed securities.  According to JP Morgan analyst Alex Roever, “current investors are at risk of having to hold positions until maturity, which in a few cases may be 40 years away.”            

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