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I can't make peace with the recent news that Citigroup (NYSE: C ) , Merrill Lynch (NYSE: MER ) , and UBS (NYSE: UBS ) will repurchase a combined $44 billion worth of so-called auction rate securities from clients caught in the middle of the credit crunch.
Perhaps I can't quite muster sympathy for these folks because I wasn't hit by the allegedly deceptive sales practices of which the banks are accused. Bank of America (NYSE: BAC ) , JPMorgan Chase (NYSE: JPM ) , and Goldman Sachs (NYSE: GS ) , among others, have also been hit with criticism, although they haven't yet settled with clients. Still, the whole thing kind of upsets me.
Trust me …
Long story short, auction rate securities are essentially long-term debt products whose interest rate is reset every handful of days at an auction. As the credit market seized up earlier this year, the auctions fueling these products disappeared, leaving clients who tried to redeem their "cash equivalents" high and dry. It wasn't that the products were necessarily worthless -- just that the auctions that determined their value simply vanished.
In order to quell clients and regulators who've called foul, the three banks mentioned have agreed to make their clients whole, essentially buying back the products they sold them.
First, the lawsuits against the banks claim the products were sold as "just like cash." Whether or not the brokers were truly being deceptive, I have a hard time understating how someone investing into a product with the word "auction" in it could honestly believe there wasn't market risk involved. Second, the products provided superior returns to cash. You don't need a tremendous amount of investment knowledge to realize fixed-rate products with superior returns invariably come with superior risk. It's the same reason junk bonds have higher yields than treasury securities.
Auction rate securities -- among who-knows-how-many other leveraged investment products -- are in the middle of an unprecedented credit crunch. Investors, even when claiming to be misled, have to accept a certain degree of responsibility for their investments, especially when those investments are caught up in a once-in-a-century storm. Swarms of homebuyers got suckered into mortgage products their brokers passed off as safe, only to quickly learn otherwise. They're hardly getting a break, nor should they. That's how risk-taking works.
Lambasting banks for selling products that fizzled opens up a whole new can of worms. If a lawsuit follows every case of investors not getting what they wanted, you'll get the opposite of the moral hazard effect: Brokers may shy away from advising responsible risks, for fear of being called out.
Further completely honest Foolishness: