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Investing Idle Funds: Some Risks, But Greater Yields

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Franz Zwicklbauer doesn't pretend to be an expert in high finance. He has so many other responsibilities, he says, that he doesn't have the time to study the markets and stay current on esoteric new financial instruments.

Yet as assistant superintendent for business for the Bethlehem Central School District in New York State, Mr. Zwicklbauer makes investment decisions almost daily, with millions of dollars hanging in the balance.

Pressed to maximize district revenues, he constantly shops with local banks for the highest rate of return on his idle-cash balances. "We've had all sorts of pressure local-ly to expand money for education, and investment income is one source I can turn to," he says.

Last year, along with a lot of other experienced school business officers in the state, Mr. Zwicklbauer got burned.

In keeping with a ruling from the state comptroller's office that freed districts to deal with financial-management companies, Mr. Zwicklbauer added one such firm, National Money Market Securities, to the list of bidders for the district's idle funds.

A year later, a government securities firm, Lion Capital Group, went bankrupt, taking down with it $390,000 that the school district had invested in it through National Money Market.

As a result, Mr. Zwicklbauer says that although it may cost the district some interest earnings, he is now making only the safest of investments.

"No longer will I bear the pressure from the board of education saying, 'Can't we increase the investment income and get the tax rate down?"'

"No more," he says.

Pressure for Profits

Mr. Zwicklbauer's dilemma is instructive in several respects.

First, his current investment posture is typical of New York districts, many of which, according to one expert, have become "ultraconservative" in their investments since the failure last year of Lion Capital and RTD Securities Inc., another firm involved in the bankrupcy.

Second, it points to the increased pressure on school business officers generally to maximize investment income, which leads them to take greater risks. Some districts earn as much as 5 percent of their revenues from short-term investments, creating a powerful incentive to invest.

(Last month, an $8-million investment of the Memphis school district--which had been pursuing an agressive investment policy--was caught in the collapse of esm Government Securities Inc., a Florida-based firm whose failure also caused a bank panic in Ohio.)

Investment vehicles typically available to districts include certificates of deposit, U.S. government securities, state and municipal bond obligations, repurchase agreements, and money-market funds.

"We're trying every means we can to make as much as we can," says J. Laurence Thompson, director of budget management for the Atlanta public schools. "We call up banks each day so we can invest the maximum each night. We know when our debits clear so we can invest the rest. We are looking at all means."

In the case of Atlanta, that includes $10 million in overnight investments, which the district started making less than two months ago, Mr. Thompson says.

More Aggressive Strategies

Not all districts enjoy the same investment opportunities. States regulate investment of public funds, and regulations differ from one state to another.

Moreover, in some states, particularly in New England and the Southeast, districts are fiscally dependent on other local-government entities and have no authority to invest funds.

But investing districts typically do whatever they can to maximize yield.

"More and more districts are doing more and more things," says Guilbert C. Hentschke, dean of the school of education at the University of Rochester, who is a recognized authority on the subject. "It's almost inevitable that a district that didn't do anything 20 years ago now does."

But according to Mr. Hentschke and others, the pressure to maximize returns is in many cases not matched by expertise in cash management. School districts are slowly becoming more sophisticated investors, but not without some costly mistakes.

"Expertise is very thinly spread," Mr. Hentschke says. "It's going to be a long time before all school districts do a good job in this area."

Cash-Management Vogue

According to Mr. Henschke and others, the application of cash-management principles to school-district finances is not new.

The Philadelphia school system, for example, instituted a cash-management program in 1974, and now invests as much as $200 million on a given day, with interest earningsel15lprojected at $15 million for 1986.

Observes James Lynn, treasury supervisor for the system, "It's in vogue now. Everyone seems to be doing it."

More districts are playing the cash-management game because many of them have only recently become aware of the value of their cash, experts say. High interest rates and tight budgets have heightened their awareness, while the deregulation of the banking industry has provided them with a variety of investment opportunities.

"Back when interest rates were 3 or 4 percent, people didn't pay much attention to cash management," says Thomas Pape, assistant deputy treasurer for the state of Illinois.

"The potential benefits from an aggressive investment posture were not worth it," adds William H. Wilken, former president of the Nation-al School Boards Association. "But with real interest rates at an all-time high, that situation is clearly different."

School districts' heightened investment activity has attracted the attention of brokerage firms, like National Money Market, which now solicit their business. It also may have contributed to the emergence of statewide investment pools for school districts, which the E.F. Hutton investment firm now markets in three states. (See related stories on this page and page 15.)

Uneven Cash Flow

Cash management starts with knowing when a district will receive its operating funds--generally from local tax receipts and state aid--and when it is obligated to spend those funds. Because districts typically receive large lump sums at specified intervals throughout the year, they can expect to carry cash balances.

But at other times, districts may become heavy borrowers because their receipts lag behind their scheduled payments. In New York State, for example, districts get about 70 percent of their state aid in the last few months of the school year, forcing many of them to borrow early in the year to meet expenses.

Authorities in other states, aware that districts invest state funds, have spread out their aid payments, keeping districts on a tighter rein and investing the funds themselves.

Minnesota has taken this strategy to its logical extreme, timing aid payments to districts' payment schedules. In doing so, the state has eliminated its own need to borrow, according to Ron Hackett, director of education aid, budgeting, and analysis for Minnesota's finance department.

Districts with savvy business executives, and less-restrictive state policies and practices, have squeezed the maximum from their funds for years by "fighting for the float"--the lag time between when money leaves one party's account and is credited to another's--and investing their cash balances for the longest possible period to gain the highest yield.

As Mr. Henschke has written: "To speed up intergovernmental transfers by a few days, school districts' managers have flown couriers to pick up checks, set up wire-transfer services, and created letter-of-credit financing methods to speed the inflow of funds. To slow down the outflow of funds, some district managers have resorted to paying bills only once a month (rather than continuously as they are received) and to aging accounts even more when the penalties for doing so appear to be less than the benefits of holding the money longer."

While the largest and most sophisticated school districts have been using cash-management techniques for several years, the concept is new to many others, particularly small, rural districts, which have tended to trade deposits for perquisites at the local bank.

'Taking Advantage'

"The banks were just taking advantage of them, frankly," says Mr. Pape.

Some smaller districts, however, have been able to work out profitable arrangements with banks.

In Huntsville, Ala., for example, William S. Daniel, comptroller for the Huntsville City Schools, worked out an arrangement with the First Bank of Alabama under which the district's deposits are placed in a consolidated trust account, which the bank then invests in other institutions.

When the district needs to meet its payroll or other expenses, the bank, which gets 5 percent of the profits on the district's money, simply transfers funds into a separate checking account.

This investment strategy earns the district more than $100,000 annually, according to Mr. Daniel. About $20 million--nearly half the district's $42-million budget--is invested in the course of a year, he says.

Prior to his arrival on the scene some six years ago, Mr. Daniel says, the district routinely placed its idle cash in a savings account at the local bank.

What led Mr. Daniels to change that policy? He answers succinctly: "I came from business into education."

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