Op-Ed: Banks buying back auction rate securities: Ethics, or legal liabilities?

Who’s liable, when you sell securities that turn out to be duds? Did you know they were duds when you sold? Can you get away with security murder, if it's not too clear who got murdered and how much they got murdered? Nobody’s too sure about that, and some of the backstage maneuvers are looking decidedly like risk management on the grand scale. To be strictly fair about this, there is such a thing as “Buyer Beware”. However, if you go to the supermarket, and buy a can of baked beans, it’s arguable that you as a buyer have far more idea of what you’re buying than the average securities investor has had lately. The general impression is that anything which could be vaguely conceptualized as a security was sold over the last few years. The market is now very wary of the word “securities”. One of the reasons is that everything from home loans to the second mortgage on Little Billy’s pet gerbil was bundled up and offloaded on securities investors. There was no safety net, no convenient trampoline at the bottom of the cliff, just a sheer drop. Wile E Coyote wouldn’t touch securities these days. So Citigroup and Merrill Lynch are either in Gandhi mode, or they’re doing some damage control. It’s just possible that they’re not really going to take their begging bowls and starve with their people, so some other theories are rattling around the Wall Street ghost towns. The New York Times:

Citigroup will buy back $7.3 billion of the securities and pay $100 million in fines as part of a settlement with state and federal regulators announced on Thursday morning.

Hours later, Merrill Lynch, without entering into a settlement, offered to buy back $10 billion of similar securities that it had sold to thousands of individuals. Neither firm agreed to reimburse institutional investors.

The moves are likely to pave the way for other banks and brokerage firms to take similar actions. The Securities and Exchange Commission is examining about 20 firms over their sales of auction-rate securities, and the New York attorney general’s office and 12 other state regulators are conducting at least a dozen similar investigations, according to people briefed on the situation.

Bank of America, the largest retail bank, said Thursday that it had received subpoenas from federal and state regulators related to sales of auction-rate securities, which are preferred shares or debt instruments with rates that reset regularly, usually every week, in auctions overseen by the brokerage firms that originally sold them.

Firms including Goldman Sachs, Lehman Brothers, JPMorgan Chase, Morgan Stanley, UBS and the Wachovia Corporation are also among those under scrutiny by regulators.

Meaning practically every big name firm in the country. The bit about not reimbursing institutional investors is a very dark patch, with all the transparency of a black hole. That could mean anyone from hedge funds to your friendly/hysterical and paranoid neighborhood pension fund. To say that the SEC hasn’t exactly been terrorizing this neighborhood in the past would be a slight understatement. The state Attorney Generals, however, notably New York, have apparently been applying some prodding. A complex set of connections has brought about this outreach program to investors. Even if some persuasion is required, this sets a precedent, which is important, because it means there’s now a working model for dealing with the unholy mess in the securities industry. It’s also apparently intended to operate as an incentive to the rest of the kids in the financial playground to come and take their medicine. Everyone wants to see the end of the fiasco, but the banks are still suffering from shortages of money, thanks to the big losses. There’s a sort of valuation to be made here. The relative value of ever again having the slightest plausibility in the securities industry, versus a few bucks paid back to people. Those few bucks are buying back a credibility the industry has done nothing to deserve. Banks should know that real money comes from only one source, people with real money. They should respect that source, because it underpins everything they do. There’s quite a lot of detail in the various situations, positions and deals that equate to “Give the nice people back their money, Buttercup, and we won’t shoot you.” The sentiments are expressed much more politely, but there’s no lack of legal ammo if they don’t deliver. That doesn’t mean anything is simple, of course, particularly the thinking:

Mark Herr, a Merrill spokesman, said the company views the securities as high-quality assets whose credit has not been hurt; investors’ inability to sell them is the investments’ only problem.

“Our clients have been caught in an unprecedented liquidity crisis,” John A. Thain, Merrill’s chairman and chief executive, said in a statement.

The fact that the market killed the value of their client’s securities with its very own little bow and arrow, (or in market speak "owe and borrow"), is neither here nor there, obviously. Come off it, people. Would you go buy a can of baked beans, if the headlines were full of nothing but the number of people getting killed while holding baked beans? You want to be an industry, act like an industry.