Taxpayers question states’ exotic investment choices
NEW YORK » State treasurers from Florida to Maine to Montana have found themselves in the awkward position this past week of having to explain why they parked taxpayer money in some of the most opaque investments on Wall Street.
More than a dozen state-run cash pools that manage money for local governments have some exposure to mortgage-related and other high-risk holdings that roiled credit markets this past summer, according to rating agency Standard & Poor's.
The fear now is that the same subprime-mortgage turmoil that triggered multi-billion-dollar writedowns for Wall Street's biggest banks might trickle down to teachers, civil servants and even the vendors delivering supplies to schools because of the way public funds were invested.
Troubles first emerged as Florida officials disclosed their $27 billion investment pool had about $2 billion sunk into subprime-tainted debt -- and $725 million of that had already defaulted. Local governments rushed to withdraw about $13 billion from the battered fund, and there are worries similar runs might happen elsewhere.
State finance officials that invested in mortgage-related instruments say they were lured by the sterling credit ratings of the issues and a promise of a 2 percentage point or higher return than could be earned on three-month U.S. Treasury bills, which now yield about 3 percent.
"We relied on professional advice from our brokers and rating agencies," said Maine State Treasurer David Lemoine. "And then there's an unprecedented collapses of a super-highly rated investment almost overnight."
Lemoine called it "inconceivable until it happened." He invested about $20 million, or 3 percent of Maine's $725 million cash pool, in commercial paper issued by what are known as structured investment vehicles, or SIVs. Though no money has been lost so far, Lemoine said it could take months to unravel what was originally intended to be a short-term investment.
SIVs are typically offshore investment vehicles created by banks and other firms to sell commercial paper, a form of low-yielding short-term debt that typically comes due every 30 to 90 days and is typically rolled over into new issues by those holding them. The cash generated from those sales was used the proceeds to buy higher-yielding mortgage securities.
These paired transactions were profitable as long as the SIVs collected more on the mortgage investments than they paid to borrow. But that breaks down if SIVs are unable to continue borrowing money, which could force them to sell the underlying mortgage-related securities at fire sale prices. In worst-case scenarios, that could leave commercial paper buyers holding the bag, since the SIVs could only pay them back a portion of the money they are owed.
What makes the situation more daunting is that nobody on Wall Street is exactly sure how many investment pools have money tied into SIVs or other subprime exposure. Rating agencies monitor investments in less than 100 government-run cash pools, and there are hundreds of others that go unrated.
California's $61 billion Pooled Money Investment Account is the largest fund that doesn't carry ratings, though managers say it has little subprime exposure. There are also hundreds of others -- from tiny municipalities to local water districts -- that operate under the radar.