Citi, Merrill Forced to Pay Delinquent Paper

This article sheds a little light on the collapse of the commercial paper market earlier this year, which caused the Fed to intervene with TAFs, TLSFs, and PDCFs as taxpayer sponsored sources of emergency capital for the banking system.

Apparently, banks simply stopped paying back auction rate securities when they couldn't find new cyclical buyers from the private sector, and since these bonds are regarded as very safe places to store money, naturally the market collapsed.

Regulatory forces have directed Citibank to reimburse small investors $7.3 billion—and there is more with institutional investors not covered—plus a $100 million fine. Under the gun, Merrill Lynch is paying back $10 billion to small investors, again with more due to institutional investors, and Bank of America is being subpoenad.

The article states auction rate securities are a $300 billion market, and indeed, that is about the combined value of TAFs, TLSFs, and PDCFs. This rotating source of low-interest capital has now been subsidized by government so it only makes sense that the private investors be paid back from when they were left holding the bag.

ADDENDUM (8/8/08): Today UBS is similarly on the hook for $19.2 billion, and a $150 million fine. (8/11/08): Add Morgan Stanley to the list for $4.5 billion. (8/15/08): Wachovia agrees to pay $9 billion, and the Attorney General's office of New York has decided Merrill's agreement to pay $10 billion was not enough and needs to pay more. (9/12/08) Fidelity, the seller of asset backed securties, takes a $300 million hit.