Russell Paquette liked auction-rate securities (ARS) as much as the next treasurer. At Recreational Equipment Inc. (REI) in Kent, Wash., he had been particularly attracted to those backed by student loans. "They were AAA-rated, over-collateralized by 30% and roughly 97% guaranteed by the Department of Education," the REI treasurer points out. But when asset-backed investments began to lose their auction market liquidity, an alert Paquette bailed out of ARS investments. "We exited that market in December and January," he notes. "We were fortunate."

A neighbor down the road in Redmond, Wash., also invested in the ARS market and escaped intact. In 2006, when the SEC ruled that auction-rate paper no longer qualified as a cash equivalent, Microsoft Corp.'s treasury saw an opportunity in the market dislocation that followed and decided to buy. "At a time when others were selling, we went overweight in auction-rate securities, relative to our benchmarks," reports Microsoft treasurer George Zinn. It was a big bet. "We went overweight by billions of dollars," he explains. "That allowed us to reap considerable value and outperform our benchmarks by taking advantage of the dislocation. We bought auction-rate for all our portfolios where it was permitted, including our liquidity portfolio."

But in early 2007, Zinn and his team of CFAs became leery of credit risk and began to pare down Microsoft's ARS holdings. Then last summer, his staff noticed collateral in Microsoft's securities lending portfolio that it wouldn't buy for its own portfolios. It called in its two securities lending agents and asked for a fix. "One offered to rewrite its guidelines and take back the securities we didn't want," Zinn recalls. "The other one wouldn't. We ended that relationship, marked the collateral to market, sold it and took a $100,000 loss. When I saw that an investment bank would burn a relationship over $100,000, I knew there were larger issues down the pike." By the end of the year, Microsoft's ARS investments were down to "the equivalent of zero," Zinn says. "We navigated the troubled waters superbly."