Bad Paper

Investors in auction rate securities issued by student loan agencies are receiving 0% interest in some cases.  Securities issued by the Pennsylvania Higher Education Assistance Agency have been paying no interest since a failed auction on April 4, 2008.  A Utah State Board of Regents bond is also currently paying zero interest.  This is the result of provisions in bond agreements to insure that interest payments on the securities do not exceed the amount of interest received from the underlying loans.  The 0% provisions usually kick in after a run up in the interest rate following a failed auction.

Mike Saunders, an asset manager for Roundstone Advisors is quoted in Bloomberg saying “It’s hard to explain, to conceptualize or even understand how someone can borrow money and not pay you interest. The investor loves you when he sees the 10 percent coupon, but how do you explain to him that it’s gone from 10 percent to zero?”