LaDonna and Kurt Shively thought they were doing the right thing when they placed $300,000 into auction-rate securities at the recommendation of a UBS Financial Services branch vice president last year.

The Waimea, Big Island, couple had always invested the money in their home-building business, but needed to park the money someplace while they were temporarily living in Las Vegas.

LaDonna Shively said the two had many questions about auction-rate securities but were assured they were a safe, low-risk way to get investment returns that were above what they'd get with a money market account.

Now the Shivelys wish they'd never heard of them. They've been unable to get their money out of the investment since last month's collapse of the $330 billion auction-rate securities market.

"We've worked for 30 years to make this money," said Shively. "This money did not come easy."

Investors such as the Shivelys are learning that auction-rate securities are not as safe as advertised and that, despite brokers' representations, they are much more risky than placing the money in a money market account.

On the other side of the ledger, Hawai'i governments, hospitals and student loan funds that issued auction-rate securities face having to pay more interest in the wake of the meltdown.

About $430 million of these securities were issued by Hawai'i entities, according to Bloomberg LP data.

It's thought that many of the buyers of the local auction-rate securities were local investors and companies because the securities were exempt from Hawai'i and federal income taxes and were — until recently — a way to get a better return on a short-term basis.

"The market is very uneasy about any kind of auction-rate product at this point," said Scott Kami, administrator of the financial services division at the state Department of Budget and Finance.

A 'CASH EQUIVALENT'

Auction-rate securities have been around since the mid-1980s and have been marketed as a near "cash equivalent," meaning they could be deposited and withdrawn almost as if they were in a bank. The money went into short-term bonds carrying interest rates that were set auctions that occurred weekly or every 28 or 35 days.

The market had for the most part operated smoothly with investors entering and exiting the investments through the auctions.

If there were not enough buyers at auctions, the dealers who supported the market stepped in to buy up securities.

But the market froze last month as dealers such as UBS, Merrill Lynch and other firms stopped buying most of the unsold auction securities.

The pullback was the result of the subprime mortgage insurance crisis, financial problems suffered by insurers of these securities and the inability of dealers to take on more risk.

In effect, those left holding the unsold auction securities couldn't get their cash out.

"These depend on a well-functioning credit market and we don't have that right now," said Louis D'Avanzo, portfolio manager of the $170 million Hawaii Municipal fund that invests in local tax-free bond issues.

"When that happens, you're not getting paid enough to hold these things."

D'Avanzo said he's bought the auction-rate securities in the past but got out of them about a year ago as he began wondering about credit markets.

HIGHER INTEREST RATES

The fallout from the market collapse has been twofold.

First, with auctions failing, investors like the Shivelys can't sell their auction-rate securities and move their money elsewhere.

Second, because of the way the market is structured, governments, hospitals, student loan funds and others who issued the auction-rate securities are finding they have to pay more. When auctions fail, a "maximum rate" clause in the securities goes into effect, with the issuer typically having to pay a higher pre-determined rate of interest. Reportedly some issuers on the Mainland are now having to pay rates ranging between 12 percent and 20 percent.

Locally, the state Housing and Community Development Corp. and Queen's Health Systems are having to pay about a percentage point more. Other local entities that have issued such debt include the City and County of Honolulu and a student loan fund.

Queen's maximum rate is a multiple of the benchmark London Interbank Offered Rate and has only risen slightly, said Richard Keene, chief financial officer of the health system.

"It's gone up a little bit," Keene said, adding that Queen's financial strength remains good and that investors are continuing to get whatever interest rate is due them.

LOCAL BORROWERS

The City and County of Honolulu issued two wastewater system revenue bonds as auction-rate securities in 2003. The average interest rate paid on them has been 2.66 percent. But since an auction failed on March 6, the maximum interest rate clause went into effect and the city is now paying 5.163 percent.

For each 0.01 percentage point increase in interest on the securities the city pays an extra $10,920 per year in borrowing costs.

The city said using the bonds has been generally positive since — until recently — they had a lower borrowing cost than fixed-rate bonds.

Unfortunately for the Shivelys, they invested in auction-rate securities from closed-end funds that don't have a significant increase in interest rates when auctions failed. LaDonna Shively finds it galling, too, that her efforts to take money out of auction-rate securities days before the market collapsed was met with assurances from a USB representative that her money was safe.

"We trusted that she knew what she was doing" said Shively, who's sent letters to U.S. Securities and Exchange Commission Chairman Christopher Cox and others, along with urging Congress to investigate. "This is like a nightmare."

ANGER AND DISTRUST

A UBS spokesman responded the bank is committed to addressing client concerns.

"We are working with clients, on a case-by-case basis, to address their immediate liquidity needs, offering such solutions as margin loans and lines of credit at preferred lending rates," said spokesman Kris Kagel in an e-mail.

"In addition, we are committed to working with our peers and industry groups to develop solutions to restore liquidity."

Shively chuckles at the notion of taking a low-interest loan from a company that helped get her funds frozen. She said UBS will get all of her money if the market remains frozen and the couple can't repay.

Hawaii Municipal fund manager D'Avanzo said he believes there could be some changes to marketing of the instruments, especially since there were probably representations that the market would always be liquid. Problems with finding buyers for auctions will probably clear up in coming months, he said.

Shively said she'll go back to putting money in real estate if and when her money comes back.

"I'm afraid to have any money in the bank now," she said.

Reach Greg Wiles at gwiles@honoluluadvertiser.com.