I think Chamois pretty well covers the potential resolution(s) but i add one more, the use of debt.  Believe a couple of management companies are gong this way already.  For more detail the CEFA site has links to some of the investor info letters put out by some funds. The crux is what will be the eventual cost of debt.  So far I haven't seen any info from my funds.  But at least the curve is going int he proper direction!

Anyone can sue anytime for pretty much any reason.  But I imagine the suits would be against the management company, Nuveen, Calamos, etc. and not the funds themselves   

Gentlemen, thank you for your learned and reasoned responses. I appreciate your forebearance for a pilgrim in this neck of the woods.

Let me ask a follow-up question: If there is no legal obligation on the part of the CEFs to redeem ARPS in the event of failed auctions, why are CEFs seeking-out potentially higher-cost structured solutions, i.e., substitute securties or bank debt, as capital sources to redeem the ARPS?  Are the CEFs assuming a moral obligation on behalf of the ARPS shareholders in response to a tacit admission of an implied understanding of liquidity in the preferred auction process?  Alternatively, are they doing it to restore confidence in CEF's non-equity obligations as leverage increases the size of CEF portfolio and the potential for management fees? 

Also, I'd be interested in knowing what's the implied secondary market discount for such securities? 

And, yes, as the saying goes, "you can sue anyone for anything or nothing at all."  I subscribe to Shakespeare's sentiments, "The first thing we do, let's kill all the lawyers." (Henry VI, Part II).

Again, thanks for your thoughful responses.  The participants on this site make it a great way to get educated in this sector.

Eqinc

Hello again!  I didn't mention debt as  an "additional cure," because you had already  listed it as a remedy.  Gerry is certainly right that bank loans are a suitable alternative in many CEF.

I'm not sure how altruistic the CEF are; they are looking for the lowest cost of leverage, and it may well be not the current APS auction failure rate, even though the latter is not that bad.  Also, from an industry perspective, there is an incentive to resolve leverage as an investment issue per se.

Perhaps someone here knows about the pricing of CEF APS in the secondary market.  I suspect sales there are pretty slim.   Best wishes!

http://news.morningstar.com/newsnet/ViewNews.aspx?article=/PR/20080319AQW096_univ.xml

I listened to the conference call which I really didn't understand, but it may be of interest to some.

EqIncome:

Let me ask a follow-up question: If there is no legal obligation on the part of the CEFs to redeem ARPS in the event of failed auctions, why are CEFs seeking-out potentially higher-cost structured solutions, i.e., substitute securties or bank debt, as capital sources to redeem the ARPS?  Are the CEFs assuming a moral obligation on behalf of the ARPS shareholders in response to a tacit admission of an implied understanding of liquidity in the preferred auction process?  Alternatively, are they doing it to restore confidence in CEF's non-equity obligations as leverage increases the size of CEF portfolio and the potential for management fees? 

The board of directors of the funds have a fiduciary duty to act in the best interests of both the common and preferred shareholders.  They can't screw the preferred shareholders to benefit the common shareholders or vice versa.

Recent article by the NYT

http://www.nytimes.com/2008/03/30/business/30gret.html?ref=business

If the broker is forced to buy back the ARPS from the shareholders, can they use their  newly acquired ability to borrow from the FED to finance this action?

What we are looking for is the return of liquidity in the auction rate market. Maybe the solution requires a compromise from all parties and some help from Uncle Sam? 

(1) The broker agrees to guarantee  the auctions. (2) The Fed agrees that when an auction fails, the brokers can borrow from the fed, at the penalty rate of the ARPS. This guarantee will bring liquidity back, and the Fed will very likely not be impacted as buyers return. The buyers will return  once the confidence in the success of the auction returns.

Who are the winners in this scenario?

Common shareholders of CEF's - (The leverage uncertainty penalty  currently priced in to the  stock price will fade)

Preferred shareholders of ARS - (Liquidity)

Broker's - (Litigation evaporates)

Issuer's - (They can go back to the business of generating returns)

US Citizen's - (CEF's invest funds in businesses and municipalities  and make loans that benefit the general public)

 Who are the losers?

The Lawyers. 

Sound like a crazy idea? Heck we are in a crazy situation.

Manny E.:

(1) The broker agrees to guarantee  the auctions. (2) The Fed agrees that when an auction fails, the brokers can borrow from the fed, at the penalty rate of the ARPS. This guarantee will bring liquidity back, and the Fed will very likely not be impacted as buyers return. The buyers will return  once the confidence in the success of the auction returns.

Please email that idea to Mr. Bernanke.  Thanks.

That, imho, really isn't a solution for the dutch auction process, the main purpose of which is to find a short term interest rate which will clear the entire auctioned quantity.  The broker can always offer to buy the auction preferreds at par from disgruntled customers in what amounts to a secondary market,  but if he offers a lower price, then he is faced with a mark-to-market situation for shares held by all other clients.  Further, this isn't a one broker problem. Brokers are not likely to "guarantee" an auction which could then be gamed by others

The owners of CEF APS have no right to "put" back  their shares to anyone, so creation of an issuer (or broker) liquidity facility for that new purpose might exacerbate the underlying problem.   It would also presumably take a new demand security (eg VRDS) to implement that arrangement, if it were to apply to all APS holders and not just to "duped" clients.  JMO as always

Always good opinions.

The problem is that the maximum rate paid by the issuer is not juicy enough to make up for the possibility that the buyer might get "stuck" with his purchase?

In the end what we want is to get confidence back in this market.

Maybe a new demand security is the answer, my thought was to create an underlying trust, which now a days might require the Fed's implied support. Once this market gets un-stuck, I expect the Fed will have little if any role.

Thanks for your patience.

Lili...

Thank you for your reference to the NYT's article.  It was a "ground zero" article.

It's my impression that the fiduciary obligation to the ARPS holders by the CEFs do not include providing liquidity for the auction process.  Based upon my limited knowledge of the area, it would seem that the fiduciary responsibility of the CEF is to the common shareholders. Actions taken by the CEFs to resolve the ARPS liquidity problem may be predicated on the fact that a non-functioning ARPS auction market is not good for the common shareholders as it will reduce leverage and potential for higher yields to the common--and, if I can be allowed to be cynical, assets under management and related fees for the managers.

"Avarice, the spur of industry" -David Hume, Essays

Thanks of the help.

Best, Eqinc