The Asset Backed Commercial Paper parade just keeps on rolling as Public School Funds across the country are Hit by SIV Debts Hidden in Investment Pools.
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.
All told, there were about 100 such pools, containing more than $200 billion at the end of 2006, according to Westborough, Massachusetts-based iMoneyNet, a research firm that tracks these funds.
Public fund managers say they’ve bought SIV debt because it had the safest credit ratings and offered higher yields than other short-term fixed-income investments.
Among the places caught up in the SIV and subprime snarls are Connecticut, Florida, Maine, Montana and King County, Washington. Public funds hold $1 billion of defaulted asset-backed commercial paper, including $273.5 million from SIVs. Montana entrusted $465 million, or 19 percent of its $2.5 billion investment pool, to SIVs.
Nobody knows how much more pain is coming. State funds could lose hundreds of millions of dollars, says Lynn Turner, chief accountant of the U.S. Securities and Exchange Commission from 1998 to 2001.
“If you’re dealing with short-term money market funds, people expect those to have low risk and not be invested in these SIVs and other very high-risk instruments,” Turner says.
The Seattle-based King County Investment Pool fund, which manages cash for about 100 agencies in the county, invested $153.5 million in commercial paper issued by three SIVs, each of which enjoyed the top grades from S&P; and Moody’s until weeks before they defaulted.
King County finance director Ken Guy says he thought the fund was making a safe investment when it bought $53.5 million in commercial paper of an SIV-lite called Mainsail II in July. Mainsail failed to make payments to investors, including King County, on Oct. 4.
Merrill Lynch also sold Mainsail paper to Maine. The State Treasurer’s Cash Pool bought $20 million in Mainsail paper on Aug. 8. That represents about 3 percent of the $726 million fund, according to Deputy Treasurer Barbara Raths.
State fund managers looking for more information on SIVs won’t find it in SEC filings; there are none. SIVs, which are companies with no employees, aren’t required to publicly disclose audited financial statements.
“You don’t actually know much about the collateral pool until after you’ve made the investment,” says Darrell Duffie, a professor of finance at the Stanford Graduate School of Business in California.
One man who buys CDOs and SIVs is Michael Lombardi, the $97,609-a-year civil servant who manages Florida’s $27 billion investment pool in Tallahassee. In August, Lombardi, 50, who has managed the pool for four years, was investing public money in asset-backed commercial paper yielding as much as 6.7 percent, even as the subprime collapse was in full swing. He declined to comment.
As of Oct. 31, the Florida fund owned at least $1.5 billion of assets that failed to meet the state’s requirement that its debt holdings have top credit ratings because of downgrades, according to state records obtained under open records laws. That was 5 percent of the pool.
Every day, Florida officials post on the pool’s Web site its daily and monthly yields, which are among the highest in the nation for local government investment pools, according to Tracs Financial, a Park City, Utah-based research firm.
The $27 billion Florida pool, the largest in the U.S., has invested $2 billion in SIVs and other subprime-tainted debt, state records show. About $725 million of these holdings have already defaulted. As of Oct. 31, Florida hadn’t disclosed its defaults or junk-rated debt. At the Nov. 14 public meeting, no state official said any holdings had defaulted.
“It’s a case of see no evil, hear no evil, speak no evil,” says former SEC chief accountant Turner. He adds that local school districts and other pool participants should be fully informed of defaults in debt held by the fund.
The people managing those pools absolutely had no idea what they were buying. No doubt they all thought they were geniuses too even as every single one of the blindly bought anything top top rated as if there was no risk to the extra yield they were receiving.
This is yet another painful lesson in the well established concept of “There is no free lunch”.
No doubt this will lead to calls for government regulation of the rating agencies, when it was government sponsorship of the big three rating agencies that created the problem. This disaster for public schools is just another in a long list of reasons why It’s Time To Break Up The Credit Rating Cartel.
Mike Shedlock / Mish
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