Now that Citigroup (C), UBS (UBS), and Merrill Lynch (MER) have agreed to buy back a total of about $40 billion in auction-rate securities, Wall St. will have to hazard a guess as to what value will be assigned to them as they shift onto the balance sheets of these firms. Several other big banks and brokerages, including Wachovia (WB) and Morgan Stanley (MS) will almost certainly pay cash to take back the auction-rates sold to their clients.

A number of analysts have tried to value the auction-rate paper. Several public companies which had the instruments on their balance sheets were forced to write-down their value and take P&L charges, most of which hit in the first quarter. Some individual investors could not sell their positions at all as the market for trading in auction-rates disappeared just after the first of the year.

There is little reason to believe that the $300 billion auction-rate market will become more liquid now than it has been for the last six months. That means as the year goes on banks and brokerage companies many have to take charges for the securities they will be buying back as part of settlements with state attorneys general and the federal government. Some of this paper will not be purchased from clients until 2009, which means write-offs for their value could stretch into next year.

There is no fixed rule on what value auction-rates have now or how much that could change over upcoming months. If the paper is worth 80% of its face value, Merrill, Citi, and UBS could face $8 billion in charges. That may mean each may be looking at the challenge of raising more money.

The auction-rate disaster will not be as bad and the mortgage-backed securities debacle, but it could be troublesome enough to drive bank and brokerage stocks down further.

Douglas A. McIntyre

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