Banks’ Municipal Debt Trades Face Preliminary Probe, WSJ Says

May 14 (Bloomberg) -- U.S. regulators are exploring possible conflicts of interest for banks that sold municipal bonds and bet the securities would fail, the Wall Street Journal reported, citing unidentified people familiar with the matter.
The U.S. Securities and Exchange Commission and state authorities opened a preliminary probe into municipal credit- default swap trades by banks, the newspaper said. The inquiry seeks to determine whether banks used their own capital to bet against bonds they sold and if the practice was disclosed properly to buyers, the newspaper said.
The move comes as the SEC widens its investigation, started at least a year ago, into whether banks including Goldman Sachs Group Inc. and Morgan Stanley misled investors when selling mortgage-linked securities in the lead-up to the collapse of the subprime mortgage market and global credit crisis.

The agency has been looking for abuse "across the spectrum," enforcement chief Robert Khuzami said April 16, when the SEC accused Goldman of fraud in the sale of collateralized debt obligations. Goldman says it did nothing wrong.
The municipal bond investigation may not lead to any final action, the Wall Street Journal said. All the banks declined to comment on the SEC probe and a related inquiry by California, the report said.

The U.S. government goal of making financial companies better at absorbing losses has sparked regulations aimed at preventing banks from taking on so much risk they could threaten financial stability. The latest to be accepted -- a proposal by Maine Republican Senator Susan Collins -- will require that Citigroup Inc., Bank of America Corp. and other large U.S. banks comply with higher capital standards.

California
Last week California Treasurer Bill Lockyer asked six banks how much they earned by betting against the state’s bonds, according to the report. He sent letters to Bank of America Corp., Barclays Plc, Citigroup Inc., Goldman Sachs, JPMorgan Chase & Co. and Morgan Stanley, the newspaper said. In March, Lockyer questioned how the same banks marketed contracts used to bet against municipal bonds.

Clare Williams, Barclays Asia-Pacific spokeswoman, Rob Stewart, a Bank of America spokesman, and Citigroup’s Asian spokesman James Griffiths all declined to comment. E-mails to the other three banks seeking comment weren’t immediately returned.