Officials from the enforcement division of the US Securities and Exchange Commission are talking to a number of banks in an effort to find solutions to restore liquidity, according to several people briefed on the matter.
The discussions are focusing on parts of the $330bn market that have affected retail investors unable to access their investments since liquidity started to dry up in February.
The SEC has floated the idea of large players in the auction-rate securities market, such as Citigroup, Merrill Lynch and Morgan Stanley , buying back some of the securities at their original price, several people said.
However, the plan is being resisted by several banks. They argue that holding such illiquid securities, whose price has fallen sharply, would lead to further writedowns and losses, worsening their financial plight and depleting their capital base.
“The auction-rate market will be dead for a long time and the last thing we want to do is hold this stuff on our balance sheet,” said one senior banker.
The SEC, which is among the regulators investigating how securities were sold to investors and whether they were informed of the risk they could become illiquid, declined to comment, as did the banks. However, people close to the situation say some banks are willing to devise a solution, not least to avoid draconian actions by regulators and to limit reputational damage.
Many investors have treated auction-rate securities as they would cash deposits or money market accounts. While the securities are long-term debt, interest rates are periodically reset at auctions supported by banks.
But the sector started to falter as dealers stepped back and stopped taking on unsold securities in auctions they managed.
Besides the SEC, a dozen state securities regulators and Andrew Cuomo, New York’s attorney-general, are conducting inquiries. Nearly all the leading investment banks are the subject of various investigations into the failure of the auction-rate market.
More than half of the outstanding securities have been refinanced or bought back by the issuers, according to industry sources. Municipal issuers have bought back about half the securities they issued, and closed-end funds about two-thirds. Eaton Vance, one of the largest closed-end fund issuers, last week bought back a further $300m in auction-rate securities.