The banks underwrote the auction rate securities thus propping up the market. When the bids stopped, the market failed and interest rates drastically increased to the detriment of the city. Another case of manipulation of markets by investment banks.
You can read the court order here.
Federal judge deals blow to Goldman Sachs in fight against Reno
By Brian Duggan - RGJ.com (Nov 27, 2012)
A federal judge on Monday agreed the city of Reno could take Goldman Sachs into private arbitration, bypassing the federal court system, to continue fighting for a settlement from the bank potentially worth millions of dollars.
Earlier this year, Reno alleged Goldman Sachs misled the city in 2005 and 2006 to issue $210 million in bonds on a specialized financial market that the bank insisted was safe, but ultimately turned out to be volatile when the financial shock happened in 2008. That debt, issued on the auction rate securities market, helped pay for things like Reno's downtown events center and wound up costing the city millions of dollars in higher-than-normal interest rates and fees.
In February, the city hired a team of private attorneys and took its case to the Financial Industry Regulatory Authority in New York, which acts as a private arbitrator between financial organizations and their customers. In response, Goldman Sachs said Reno needed to take the matter to federal court and asked a federal judge to stop Reno's attempt to start arbitration.
Read the article and see the court order here