by Calculated Risk on 8/09/2008 05:55:00 PM

In February the Auction Rate Securities (ARS) market froze. Auction-rate securities are a borrow short, lend long (or invest long) strategy used by cities and student-loan organizations to lower their borrowing costs.

It has been alleged that many banks marketed ARS to investors as "safe as money markets". Since the markets froze, many investors have been unable to withdraw their funds. Now the banks, to avoid legal action, are having to buyout those investors.

From the WSJ: UBS to Pay $19 Billion As Auction Mess Hits Wall Street

On Friday, facing allegations of wrongdoing over its sales of so-called auction-rate securities, UBS AG agreed to buy back from investors nearly $19 billion of the investments as part of a settlement with federal and a group of state regulators. It will start buying from individuals and charities in October and from institutional clients in mid-2010.

UBS was the third major firm this week to vow to buy back the securities, which allegedly were improperly sold as higher-rate equivalents for super-safe money-market funds.

UBS, Merrill Lynch & Co. and Citigroup Inc. have committed to taking back a total of more than $36 billion of the instruments. Other financial firms are expected to follow suit.
...
Wall Street sold more than $330 billion of these securities to more than 100,000 individuals and other investors.

This isn't a loss for the banks - although there may be some losses in the future - because the Auction Rate Securities are still paying interest. However this does tie up the banks' capital and contributes to the credit crunch.