	Introduction

Auction-rate securities (ARSs) coupled long-term maturity borrowing with interest rates linked to short-term money markets by periodic auctions, and thus combine features of short- and long-term securities. Municipalities and public authorities, student loan providers, and other institutional borrowers raised funds using auction-rate securities since they were first created in the mid-1980s. The credit crunch of 2007-2008, however, exposed major vulnerabilities in the design of ARSs, and new issues of ARS debt have effectively ceased. Following the extraordinary turmoil in global financial markets that erupted in August 2007, several interest-rate auctions for ARSs failed, which temporarily left investors unable to sell their ARS holdings. While ARS markets appeared to return to normalcy that fall, some large institutional investors had begun to withdraw funds from ARS markets. Congressional Concerns

In the past, Congress has expressed concern that the collapse of the ARS market could elevate costs of state and local government borrowing, disrupt higher education finance, and raise important questions about federal financial regulation and oversight. After widespread ARS auction failures in February 2008, the House Financial Services Committee held a hearing to examine how financial market developments may have increased borrowing costs to state and local governments. On May 1, 2008, Congress passed the Ensuring Continued Access to Student Loans Act of 2008 (ECASLA, H.R. 5715 , P.L. ECASLA allows the Secretary of Education to provide capital to student lenders, whose ability to borrow in some cases could have been constricted by ARS failures. Structure of the Auction-Rate Securities Market

		Market Composition

Municipal bonds and bonds backed by student loans have been the most prominent parts of the ARS market. Efforts to avoid auction failures put mounting pressures on investment bank balance sheets. A much smaller volume of student loan ARSs (or SLARSs) issues have been refinanced. Many issuers, such as municipalities, universities, and student lenders, were faced with steeply higher interest costs. The U.S. Securities and Exchange Commission (SEC) also reached several settlements with major broker-dealers. Most major investment banks active in the ARS market have reached agreements with state attorneys general and financial regulators to buy back ARSs from some classes of investors. Fidelity, a mutual fund group, did not originate ARSs, but sold some ARSs to clients. Some municipalities have restructured auction-rate securities debt and other issuers have redeemed portions of security issues. Interest Rate Hedges and LIBOR

Some municipal borrowers that used ARSs attempted to hedge interest rate risks through interest rate swaps linked to LIBOR (London InterBank Offer Rate). During 2008, however, that type of hedge generally performed poorly. The City of Baltimore, Maryland has sued banks involved in setting LIBOR rates, claiming that those rates were kept artificially low. In addition, ARSs created major liquidity problems for many holders of ARS debt. Issues for Congress

Recent turmoil in ARS markets has affected several policy areas of Congressional concern. State attorneys general in New York, Massachusetts and other states have filed suits alleging that investment banks active in the ARS market failed to inform clients about rising liquidity risks, especially between when the global credit crunch emerged in August 2007 and when the ARS market collapsed in February 2008. In addition, some bond contracts may restrict issuers' ability to repurchase their own ARSs. One proposed Senate amendment submitted by Senator Sherrod Brown on May 26, 2010 ( S.Amdt. 4261 ) to a supplemental appropriations measure (Disaster Relief and Summer Jobs Act, H.R. 4899 ) would let the government buy certain federally guaranteed loans, which could affect the SLARS market. 110-227 ).
Many municipalities, student loan providers, and other debt issuers borrowed funds using auction-rate securities (ARSs), whose interest rates are set periodically by auctions. ARSs combine features of short- and long-term securities. ARSs are typically long-maturity bonds with interest rates linked to short-term money markets. ARS issuance volumes grew rapidly since they were introduced in the mid-1980s. By 2007, ARSs comprised a $330 billion market. The credit crunch of 2007-2008, however, exposed major vulnerabilities in the design of ARSs.
Turmoil in global financial markets that erupted in summer 2007, combined with vulnerabilities in the structure of ARSs, put mounting pressure on the ARS market. In addition, downgrades of some bond insurers increased stress on segments of the ARS market. In early February 2008, major ARS dealers withdrew their support for ARS auctions, most of which then failed. Widespread auction failures in the ARS market left many investors with illiquid holdings and sharply increased interest costs for many issuers, such as student lending agencies, cities, and public authorities. In particular, ARS failures, according to some, have made it more difficult for student lenders that had used ARSs to raise funds.
Many major investment banks, in the wake of lawsuits filed by state attorneys general as well as pressure from state and federal regulators, have announced plans to repurchase outstanding ARSs for certain relatively smaller investors and to make efforts to liquidate ARS holdings of larger and institutional investors. The U.S. Securities and Exchange Commission (SEC) reached several settlements with broker-dealers in late 2008 and early 2009. Lawsuits alleged that some investment banks sold ARS products as cash equivalents, but failed to disclose liquidity risks and the extent of bank support for auctions—the main liquidity channel for ARSs. Many major investment banks involved in the ARS market reached settlements and agreements to buy back ARSs from some investors, typically certain individual investors, non-profit organizations, and small businesses. Some large firms and high-wealth individuals, however, have not been covered by these settlements. Some large firms have called for federal help to sell their ARS holdings.
Some municipal borrowers that used ARSs attempted to hedge interest rate risks through interest rate swaps linked to LIBOR (London InterBank Offer Rate). During 2008, however, that type of hedge generally performed poorly. The City of Baltimore, Maryland has sued banks involved in setting LIBOR rates, claiming that those rates were kept artificially low. Some parts of the ARS market, such as municipal issues and closed-end mutual funds, have restructured much of their debt, as issuers have redeemed ARS securities and switched to other financing strategies. A much smaller portion of existing student-loan-backed ARS (SLARS) debt issues have been refinanced.
In the past, Congress has expressed concern about policy areas that the ARS market's collapse has affected. For example, the House Financial Services Committee held a March 2008 hearing to examine how financial market developments may have increased interest and other financing costs of state and local governments, followed by another hearing in September 2008 on ARSs. In April 2008, Congress passed the Ensuring Continued Access to Student Loans Act of 2008 (H.R. 5715, P.L. 110-227) to allow the Secretary of Education to provide capital to student lenders, whose ability to borrow in some cases had been constricted by ARS failures. One proposed Senate amendment (S.Amdt. 4261) to a supplemental appropriations measure (Disaster Relief and Summer Jobs Act, H.R. 4899) would let the government buy certain federally guaranteed loans, which could affect the SLARS market. This report will be updated as events warrant.