Lehman Brothers (NYSE: LEH - News) faces the threat of legal action by municipal councils in Australia over the sale of high-risk collateralised debt obligations by the Wall Street bank's local subsidiary, Grange Securities.

At least two councils in New South Wales and a third in Western Australia are considering litigation against Grange, which marketed Lehman-originated CDOs to dozens of Australian councils as well as to charities and a public hospital provider.

The losses suffered by the councils and charities are further evidence of the damaging impact of the recent global credit turmoil as it spreads from sophisticated large investors to small communities round the world - and is increasingly starting to hurt mainstream, risk-averse investors such as local governments and pension funds.

The news comes as central banks worldwide prepare to inject tens of billions of dollars into the financial system in an effort to unblock seized markets, starting with a $20bn liquidity auction in New York on Monday.

Although the unveiling of that stabilisation plan calmed market sentiment last week, tensions remain high in the banking system as a whole. "The financial system is very vulnerable to bad news right now," admitted one senior central banker.

Markets are particularly nervous about the threat of imminent credit rating downgrades for monoline insurance companies. As guarantors for bond issuers, their health has crucial implications for trillions of dollars of securities round the world, many of which are held by mainstream investors such as pension funds and local governments.

Four towns in Norway saw most of the value of their investments in complex funds designed by Citigroup wiped out by the credit crisis.

Lehman has admitted that, "in very few cases", the CDOs sold by Grange breached the councils' investment guidelines because of the length of their maturity dates. It has bought back some CDOs.

The Lehman-originated Federation CDO, exposed to the US subprime mortgage market, was last month marked down to just 16 cents in the dollar by the bank, leaving councils nursing paper losses of 84 per cent.

The sale by Grange and others of many hundreds of millions of dollars worth of CDOs to Australian councils, some of which had 70 per cent or more of their total investment devoted entirely to CDOs, has sparked an investigation by the state government of New South Wales.

Lehman said the councils were suitable investors in CDOs because they were recognised as "sophisticated wholesale investors who have responsibility for their own investment decisions and due diligence". It added: "We believe that everything Grange sold to customers conformed to NSW ministerial [investment] guidelines. There will be cases where Grange does not believe, on objective grounds, they have to cancel [the CDOs]."