Dealers for a $600bn sector of the credit markets relied on for funding by cities, states, hospitals and student loan providers are seeking guarantees from the US Treasury to restore investor confidence in troubled bond products.
In a letter to the Treasury, two industry associations called for government backing to replace guarantees from banks, which are now facing their own financial problems.
It is the latest plea for support to the Treasury, which has been authorised by Congress to spend $700bn to bail out the financial system and has broad discretion over where it spends its money.
The government has already committed $250bn to recapitalising banks, and insurance companies and car manufacturers, among others, are also seeking funds.
The securities in question are auction-rate securities (ARS) and variable-rate demand notes (VRDN), both of which are structured to offer long-term financing but at short-term costs. There is an estimated $200bn of ARS and around $400bn of VRDN outstanding.
The market for ARS collapsed in February after banks withdrew their backing for the sector, leaving issuers with huge increases in interest rates and investors holding illiquid securities, which can now only be sold at a significant loss.
Treasury backing for the securities "could help avoid a circumstance where liquidity-constrained banks are forced to buy a large volume of illiquid securities", said the letter from the Regional Bond Dealers Association, which represents dealers in fixed-income securities, and the Education Finance Council, which represents student loan providers.
"The fact that so many people are going to the Treasury with so many ideas is an indication of just how broken the credit markets are," said Michael Decker, co-chief executive officer of the RBDA.
The ARS sector, which attracts large numbers of individual investors seeking a higher-yielding alternative to cash, has become the focus of numerous probes and investigations by lawmakers and prosecutors.
Banks have agreed to settle many of these cases and compensate individual investors for their losses.
The interest rates on these securities are frequently reset. The structures allow investors to refuse new terms on offer, either giving the issuer high-penalty interest rates or allowing the investor to sell the securities back to a bank or the issuer itself.
The turmoil in the credit markets is also threatening the VRDN market. Unlike ARS, these securities have explicit guarantees which allow investors to sell them if they no longer want to hold them.
The "liquidity backstops" are usually provided by banks, but the crisis in the global financial system has made banks reluctant or unable to offer such guarantees on both new and existing issues.
"The market for VRDNs, while not as dysfunctional as that for ARS, is also quite stressed," the letter said. "There are indications that the VRDN market could suffer a more widespread breakdown in the coming months."
Mr Decker said the financial strains on many banks in the US and Europe had made it difficult for even municipal and other borrowers with the highest credit standing to be able to pay for the liquidity backstop facilities. If the Treasury can provide these, for a fee, it could allow issuers to again start raising funds in this part of the markets.
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