Public funds often make for great stuffees, as this story from Bloomberg (hat tip Ann Beaulieu) recounts.
In brief: the Florida State Board of Administration runs roughly $42 billion of short-term investments on behalf of various government entities, including a “short term investment pool” of roughly $27 billion, as well as the state’s $137 billion pension fund. The pool has been hit by $8 billion of withdrawals due to the disclosure that it holds $700 million in defaulted debt.
The withdrawals are sufficiently large that the fund may be forced to declare bankruptcy.
The reporting on this isn’t as crisp as I’d like (the story also refers to the pool as a “money market fund” and later clarifies that they are “modeled on money market funds”) and one has to read a way into the story (or pull out a calculator) to ascertain the size of the troubled fund, which is $27 billion.
Similarly, the article cites $700 million in unspecified defaulted debt in the pool that has suffered the redemptions at the top of the article, later says it is $900 million and gives details, and at another point reports that there is $2.4 billion in defaulted asset backed commercial paper in the $42 billion investment portfolio, of which the “short term pool” is apparently a part. But if that is correct, that means that the $15 billion balance of that portfolio contains $1.5 billion of defaulted paper if you use the $900 million loss figure, which is 10% of assets, a higher level than in the pool suffering the redemptions. Whose investments are those, and why aren’t they heading for the hills too?
This drama hasn’t yet been picked up by the Wall Street Journal, so we’ll get more detail soon.
Florida local governments and school districts pulled $8 billion out of a state-run investment pool, or 30 percent of its assets, after learning that the money-market fund contained more than $700 million of defaulted debt.
Orange County, home of Disney World, removed its entire $370 million from the pool on Nov. 16, two days after the head of the agency that manages the state’s short-term investments disclosed the defaulted debt in a report delivered to Governor Charlie Crist.
“Our primary goal is to protect our funds,” said Jim Moye, Orange County’s chief deputy comptroller, from his office in Orlando. The county’s school board withdrew $388 million this week, following other local governments that pulled funds, including Miami-Dade County and Pompano Beach. The withdrawals, made since Nov. 14, were disclosed to Bloomberg News in a response to an open-records request.
The State Board of Administration manages about $42 billion of short-term investments, including the pool, as well as the state’s $137 billion pension fund. Almost 6 percent, or $2.4 billion, of its short-term investments consist of asset-backed commercial paper that has defaulted. Those holdings include $425 million in Axon Financial, a structured investment vehicle, or SIV, according to state records.
About $19 billion remained in the pool this week after the unprecedented wave of withdrawals, which came after the State Board of Administration reported its holdings of downgraded debt to Crist at a Nov. 14 public meeting of his cabinet in Tallahassee. The disclosures followed a month of inquiries by Bloomberg News to Florida officials.
“Knowing other people were pulling out, and that word was spreading, we looked at the potential for a run on the pool,” said Orange County’s Moye.
Coleman Stipanovich, the State Board of Administration’s executive director, didn’t return telephone calls seeking comment yesterday or today.
Should the withdrawals continue, Florida’s pool may have to consider filing for bankruptcy protection, says John Coffee, a securities law professor at Columbia Law School in New York. “A bankruptcy could handle these kinds of problems if they feel they’ll become insolvent,” he said.
Coffee predicts the pool will likely file lawsuits to recover losses. “I’d expect the pool is going to sue the people who sold them the commercial paper, saying the risks were hidden,” he said.
Lehman Brothers Holdings Inc. sold Florida most of its now-default-rated asset-backed commercial paper. Lehman spokesman Randall Whitestone declined to comment.
Thousands of school, fire, water and other local districts across the U.S. keep their cash in state- and county-run pools. These public accounts, modeled after private money market funds, are supposed to invest in safe, liquid, short-term debt such as U.S. Treasuries and certificates of deposit from highly rated banks.
The Florida pool, which was the largest of its kind in the U.S. at $27 billion before the recent spate of withdrawals, has invested $2 billion in SIVs and other subprime-tainted debt, state records show. Connecticut, Maine, Montana and King County, Washington, are among other governments holding similar investments, in smaller quantities.
The Florida pool’s $900 million of defaulted asset- backed commercial paper now amounts to almost 5 percent of its holdings. The paper, which carried top ratings from Standard & Poor’s, Moody’s Investors Service and Fitch Ratings as recently as August, was downgraded after declines in the value of collateral affected by the subprime mortgage slump.
The pool owns $168 million of debt from KKR Atlantic Funding Trust cut to D, or default, from B by Fitch Ratings on Oct. 8. It also has $356 million issued by KKR Pacific Funding Trust, cut to D from B by Fitch Ratings on Oct. 2.
Florida’s pool has another $180 million of paper from Ottimo Funding, cut to D from C by S&P on Nov. 9. The pool also holds $175 million of short-term debt issued by Axon Financial Funding, an SIV. It was cut to D from C by S&P yesterday…
At Crist’s Nov. 14 cabinet meeting, Stipanovich said that while there was “disappointment” over recent downgraded investments, no local government had ever lost money in the pool since its creation in 1982.
“I want Orange County to be first in a lot of things, but I don’t want Orange County to be the first to lose money in the state’s Local Government Investment Pool,” said Martha Haynie, the county’s comptroller, in an interview today.
Stipanovich also assured Crist and Florida Chief Financial Officer Alex Sink at that time that the pool maintained the confidence of its depositors.
“There are a lot of rumors flying around,” testified Stipanovich. “I’m not aware that there have been any material outflows.”
Moye said Orange County pulled out of the pool this month because the State Board of Administration failed to provide adequate or timely disclosure to pool participants about its troubled investments.
On Nov. 20, Pinellas County yanked its entire $300 million from the pool.
“My first job is to safeguard principal,” said Ken Burke, Clerk of the Pinellas Circuit Court. A certified public accountant, Burke controls the county’s cash. He said a quarterly newsletter for pool participants, published Nov. 1, which mentioned downgrades but not defaults, wasn’t candid about the pool’s predicament.
“If some bad news comes out, the first thing I’d do is contact my customers and give them my side. The newsletter didn’t tell us the full story,” said Burke. “It made it sound like a bump in the road.”
Neither the newsletter nor Stipanovich’s testimony disclosed that the pool owns $650 million of certificates of deposit from Countrywide Bank FSB, a unit of Countrywide Financial Corp., that now amounts to more than 3 percent of the pool’s assets. The bank’s rating was cut to Baa1, three levels above junk, by Moody’s on Aug. 16.
When local governments withdraw funds from the pool, the state must sell off holdings to raise the cash. Because Florida’s pool has been forced to quickly raise billions of dollars to meet withdrawal demands, it won’t get top dollar for its asset sales, says Joseph Mason, professor of finance at Drexel University.
“When funds like this are liquidated, the Street will take advantage of their desperation. They don’t care if you’re a hedge fund or a school district,” said Mason, who completed an 18-month appointment as a scholar in residence at the Federal Deposit Insurance Corporation in January.
Mason, who has studied the history of bank failures, understands the rush by Florida municipalities to pull their money from the pool.
“The first people in the withdrawal line get 100 percent of their money,” he said. “The loss is suffered by the people behind them in line. Since nobody wants to be at the end, you get a run on the pool.”
Mason says while the state of Florida has a moral duty to cover any losses suffered by the pool participants, its own shaky finances will make that difficult. The fourth most-populous state, hurt by the housing slump, cut its revenue projections by 3.9 percent for the fiscal year ending June 30, and 5.2 percent for the following year.
“The state appears to have breached the trust of the investors by putting money in new kinds of debt its managers didn’t fully understand, in their search for higher yields,” Mason said.