The auction-rate securities debacle holds a couple of lessons for small investors:
Lesson one: When someone tells you an investment is safe, look under the hood. No investment really is safe, although short-term Treasury bills and federally insured bank accounts come pretty close.
Lesson two: Regulators, those bureaucrats who get blamed for hog-tying American business, can be the ordinary person’s best friend; in fact, that’s their job. Investors would be out hundreds of millions of dollars had regulators not cracked whips over the brokerage houses.
One of those regulators, Missouri Secretary of State Robin Carnahan, twisted arms at St. Louis-based Wachovia Securities, a divison of Wachovia Corp. On Friday, Wachovia agreed to buy back $8.8 billion in auction-rate securities it sold to customers.
Other investment houses across the country are striking similar deals under pressure from state securities regulators. Wachovia alone has put $775 million aside to cover possible losses on the deal.

The auction-rate mess is a tale of what happens when very smart people become drunk on optimism, blind to risk and careless with sales talk.
For years, Wachovia and its brokers thought they were selling a low-risk investment. Auction-rate securities are long-term bonds that mature over 20 or 30 years. But unlike most bonds, they don’t carry fixed interest rates. Instead, the rates are supposed to be set at regularly scheduled auctions — sometimes monthly, sometimes weekly — at which investors buy and sell the bonds.
All this had been going on for several years without serious problems. Customers who wanted to cash in their auction-rate securities had little trouble selling them at auction, and brokerages were prepared to step in and play buyer if sales got sluggish. The securities looked like a low-risk place to stash cash and earn a little more than if it were in a money market fund.
Stockbrokers picked up on that theme but exaggerated it. Ms. Carnahan received complaints from investors who said their brokers had said auction-rate securities were “the same as cash” and “better than a money market” and assured them that they could “get your money whenever you want.”
Because most auction-rate securities are sold by large institutions, individual investors apparently believed that line, too. No one, big or small, thought to ask what might happen if investment banks held an auction and no one bothered to bid.

That’s what happened. The problem started with the collapse of subprime mortgage securities last summer, which sent waves of panic through the credit markets. By February, major players were hoarding cash. When auction-rate securities went on auction, no one bid.
Small investors found themselves holding 20-year bonds that they couldn’t sell, freezing their funds in place. Banks and brokerages couldn’t buy them back because those institutions were in crisis mode themselves, losing billions on their own investments. Wachovia lost $9.6 billion in the first half of this year. Auction-rate investors were left high and dry.
They would have stayed that way had state securities regulators not responded to the reports of mistaken — if not fradulent — sales pitches. Class-action lawyers also were lining up at the courthouse. Big investment banks such as JPMorgan, Morgan Stanley, UBS AG and Citigroup all have agreed to buy-backs. Several smaller brokers are holding out.
This fiasco illustrates what happens when hunger for profit overwhelms prudence. In the middle of this decade, lenders dropped their credit standards and shoved loans at people and companies that couldn’t afford them. Now they’re reaping the consequences.
When Missouri investors get their checks from Wachovia, they might write a thank you note to Ms. Carnahan.