Investors stuck in Big Dig bonds

The bonds, issued in 2000, raised $400 million to finance Big Dig construction. They were called auction-rate securities, and investors snapped them up because they were safe, paid about 3.5 percent interest, and went to market every week, making them easy to buy and sell.

But everything changed in February 2008, when all trading in the bonds froze as a result of the credit crisis sweeping the global financial markets. Since then, interest rates on the bonds have fallen to almost zero. It’s been a good deal for the state as it struggles with its budget crunch. But for bondholders, it’s been a shock: They are getting almost no return on their investment, and because trading has halted, they can’t sell the bonds to get their money back.

Frustrated investors describe being caught in a netherworld in which neither the state nor the Wall Street investment firms that sold the bonds will claim responsibility for refunding them.

“It’s Kafkaesque,’’ fumed Alex Neihaus, a Southborough resident who holds $75,000 in frozen Big Dig bonds.

Cahill’s staff said the state hasn’t refunded the bonds because it would have to do so at a much higher, fixed interest rate, which would be costly. Also, a refunding would largely benefit the investment banks that underwrote the bonds, because they have bought back billions of dollars of the investments under pressure from state and federal regulators. The investment banks, not the state, Cahill’s office argued, should be responsible for repaying individual investors.

“The settlement reached between the banks that sold these bonds and various market regulators should have provided relief for any individual investor who owned the bonds prior to their auction failure, with the banks buying the bonds back from individual investors,’’ said David Kibbe, Cahill’s spokesman. “A refunding of these bonds now by the Commonwealth would subject the state to millions of dollars in additional interest costs, and would provide a windfall to the banks on Wall Street that hold the vast majority of these bonds.’’

The state bond freeze was part of a much broader $330 billion scandal, when on the same day in February 2008 Wall Street firms all stopped trading this type of bond, which were issued by municipalities and student lenders. Regulators moved in to help individuals and small businesses get their money out. But the settlements didn’t cover everyone.

Davenport Realty, a resort and real estate firm on Cape Cod, has about $1 million trapped in auction-rate securities, one-third in Big Dig bonds. The money is sorely needed for working capital, executives of the firm said, especially after a slow summer. Davenport executives say that neither the broker that bought the bonds for them, Corby Capital Markets Inc., nor regulators they’ve contacted seem able to assist them.

“There doesn’t seem to be any incentive for the state to help the businesses,’’ said Stephen Aschettino, Davenport’s financial chief. “We’ve come up empty every time.’’

For years, auction-rate bonds were a cheap way for government entities, student lenders, and nonprofits to borrow money. They were popular with individual investors and businesses as safe, cash-like investments. And the weekly auctions reassured investors their cash would never be locked up for long.

When that didn’t turn out to be the case, many investors got their money back only after state and federal regulators brought cases against the Wall Street banks. For example, Goldman Sachs Group, which underwrote a portion of the Big Dig bonds, agreed in August 2008 to buy back $1 billion of these and other auction-rate securities. The settlements applied to individuals, nonprofits, and businesses with accounts of less than $10 million.

But 19 months later, some investors are still stuck in the Big Dig bonds, earning virtually zero interest, and fear they may have to hold them to maturity in 2030. Officials in Cahill’s office said they don’t know how many investors still hold the bonds, but noted they are receiving fewer complaints about the investments than a year ago.

Corby’s chairman was unavailable for comment. Goldman Sachs declined to comment. And regulators say they’ve done all they can to help.

Alex Neihaus, the Southborough man with $75,000 in Big Dig bonds, would beg to differ. He bought the bonds through brokerage Charles Schwab & Co., which was a middleman in selling the securities, and therefore wasn’t subject to the settlements regulators struck with underwriters such as Goldman.

Neihaus said he’s angry that he loaned money to the Commonwealth and now can’t get it back. “I fault the treasurer’s office for not insisting that Goldman make good on all of [the bonds],’’ he said. “There’s no way out for people like me.’’

New York Attorney General Andrew Cuomo sued Schwab earlier this year to force it to buy back bonds from its clients, but Schwab is fighting the case. Schwab declined to comment. Fidelity Investments settled a similar suit with Cuomo and Massachusetts Secretary of State William F. Galvin last year, promising to buy back $300 million of the bonds, while denying wrongdoing.

State Attorney General Martha Coakley acted on behalf of 21 cities and towns and the Massachusetts Turnpike Authority to get refunds on their auction-rate securities holdings from UBS Securities Inc. But Coakley has not taken action on behalf of individuals or businesses.

Davenport is among a huge number of investors trapped in another swath of auction-rate securities that remains largely untouched by regulators - those issued by municipal bond funds. Davenport has about $700,000 in auction-rate preferred shares issued by MFS Investment Management of Boston, Nuveen Investments Inc., and Van Kampen Investments Inc.

Nuveen said it has refunded customers $2.3 billion out of $11 billion invested in auction-rate preferreds. MFS declined to comment, and Van Kampen was unavailable for comment. Nuveen and other firms are trying various methods to refund the holdings, including asking Congress to let them borrow from the Federal Reserve. But it’s slow going.

Said Anne Kritzmire, a managing director at Nuveen: “Nobody quite envisioned this situation.’’

Beth Healy can be reached at bhealy@globe.com.