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Published in Print: December 12, 2007, as Fla. Fund’s Woes Spark Investment Jitters

Fla. Fund’s Woes Spark Investment Jitters

Problems in one state likely to prompt renewed scrutiny of similar pools.

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The crisis swirling around a state-run investment fund in Florida has escalated concerns among public-finance officials there and elsewhere about the investments of school districts and other public entities against a national backdrop of credit and home-mortgage woes.

Florida officials reopened the state’s Local Government Investment Pool last week, but placed restrictions on how much school districts and other government agencies will be able to withdraw from the fund. The Florida State Board of Administration had temporarily closed the fund Nov. 29, severely hindering some districts’ ability to pay their employees.

The shutdown came after several districts, cities, and other government entities—acting on reports that certain investments in the pool had been downgraded—withdrew their money in what one district business manager described as a “1920s-style scare.” As a result of the withdrawals, assets of public entities in the fund plummeted to $14 billion, from $27 billion. ("Florida Will Consider Methods of Protecting Local Investment Fund," Dec. 5, 2007.)

Trustees of the 25-year-old fund, including Gov. Charlie Crist, a Republican, turned to New York City-based asset manager BlackRock Inc. for direction on how to safeguard the money in the pool and approved a formula they hope will restore confidence.

Still, school districts with money remaining in the pool were clear that they were unwilling to settle for less than 100 percent of their funds eventually.

“The state and the SBA have a duty here to restore confidence in the pool,” said Stephen Hegarty, a spokesman for the 192,000-student Hillsborough County school district, which has more than $570 million in the pool, more than any other district in the state.

The Florida situation, while unusual, is not unique. Earlier this fall, the King County, Wash., investment pool, used by school districts and other government entities in the Seattle area, was placed on a “credit watch” by the credit- and bond-rating agency Standard & Poor’s, after two “commercial paper” investments by the $4.1 billion fund were downgraded.

In the commercial-paper market, banks and other financial firms buy the right to collect payments on residential and commercial mortgages, credit cards, and other short- and long-term debt. Recent defaults in the “subprime” mortgage sector, however, have made such investments riskier.

A King County finance committee suspended the purchase of any additional forms of commercial paper and is searching for other ways that the pool’s portfolio may have been affected by those investments.

“This means the county assumes full responsibility for recovering the principal and interest on this single investment and thereby protects pool members and the county’s overall pool rating,” according to a Sept. 3 press release from County Executive Ron Sims.

‘Few and Far Between’

Still, in the past four months, the King County action was only one taken by Standard and Poor’s. The New York City-based bond rater said in a Nov. 30 commentary that the local-government investment pools it rates have “successfully managed through the recent credit and liquidity events with little or no impact on the pools’ net asset values or ratings.” Standard and Poor’s rates 75 such pools in 26 states.

“Fortunately, these types of incidents are few and far between,” said John D. Musso, the executive director of the Reston, Va.-based Association of School Business Officials International.

Risky Business

Florida’s fiscal headache involves some common—and not-so-commonly understood—financial instruments and practices. Here are a few.

LOCAL GOVERNMENT INVESTMENT POOL:
School districts and other government entities invest idle funds in local-government investment pools, or LGIPs, until they need them, to make payroll, for example. LGIPs are meant to be highly liquid, meaning that districts can draw money out at any time. The funds are usually invested in short-term, highly rated government and nongovernment securities.

COMMERCIAL PAPER:
A short-term loan issued by a corporation, often considered preferable to borrowing money from a bank. Recent defaults in the subprime-mortgage market have affected the commercial-paper market as well.

SUBPRIME LENDING:
The practice of making loans to borrowers who do not qualify for the best interest rates because of their credit histories. A crisis in this market began about a year ago with widespread foreclosures among homeowners with adjustable-rate mortgages.

Public-finance officials also are quick to stress that such short-term investment pools are far different from typically less volatile—and more high-profile—public-employee pension funds. Such funds are expected to be able to ride out market fluctuations because they involve longer-term investments, explained Ronald Snell, the director of the state-services division at the Denver-based National Conference of State Legislatures.

“Because they are in it for the long haul, [pension funds] tend to not recognize gains and losses when they occur,” he said. “Probably, pension funds will continue to show investment gains, whatever happens in the market.”

And even in the area of short-term investments, not all school districts have their money in pools exposed to troubles in the mortgage industry.

Most districts in Colorado, for example, invest their money in Colotrust, a $4 billion pool administered by a private asset-management company. In fact Colotrust’s guarantee to its participants is “that there is no loss of funds, ever,” said Bert Huszcza, the executive director of the Colorado Association of School Business Officials.

“We don’t have similar problems” to those of Florida, he said, “and we don’t expect anything.”

In spite of the near-panic in Florida, Coleman Stipanovich, who resigned last week as the executive director of the State Board of Administration, emphasized in a Nov. 28 press release that even the downgraded investments have continued to make principal and interest payments. An earlier report to the governor said none of the fund’s clients have lost money.

Public-finance officials have good reason to be vigilant, however, since the health of a district’s investments can affect not only its cash flow, but also the price the district pays to borrow money to build schools or undertake other capital projects.

If a district loses money in the market, it’s possible that its credit rating could go down, Mr. Musso said, adding that the district would then have to pay higher interest rates. Districts with lower credit ratings might also have to pay an insurance company to insure the bonds against default, he added.

Cash-Flow Convenience

Florida’s problems put a spotlight on a little-known investment resource that often helps local government manage their cash flow.

School districts use such pools as a way to invest surplus dollars and “maximize their revenue,” said Desiree Henegar, who is the assistant budget director for the 41,000-student Sarasota County school district in Florida and serves as the president of the Florida Association of School Budget Officers. Many smaller Florida districts rely on the state-run pool because that is their only vehicle for investment, she said.

Districts often have to be able to withdraw the money for such purposes as meeting their payrolls, said Mr. Musso.

“They are working with taxpayers’ money, and they’ve got to maintain the trust of their taxpayers,” he said. “If they didn’t do that, they would be under fire.”

Larger districts in Florida with money remaining in the pool said they were still able to meet their obligations, such as paying their employees, even while the fund was closed.

“We’re fine,” Mr. Hegarty of the Hillsborough County district said, adding that property-tax payments were starting to come in. “Normally, that would go up to the pool, but now that will go directly to us.”

But the situation created big problems for some smaller school systems, which were left worrying about whether they could pay their workers or cover other routine expenses.

“What more can you do to a white-headed man who doesn’t have another gray hair to turn?” said Larry Hawkins, the finance officer for the 3,200-student Holmes County district in northwest Florida.

Mr. Hawkins said he had just entered a retirement party for a 35-year employee when he was told that the district couldn’t draw on its $5.3 million in the pool to cover the Nov. 30 payroll. Before the end of the day, he said, the district had to get a $1 million line of credit from a local bank to pay employees and keep the system operating.

Withdrawal Restrictions

Florida school districts and local governments seeking access to their money still in the investment pool will have to work under a system devised by the BlackRock financial-management firm. The fund’s trustees voted to separate the downgraded investments from the rest of the pool, and to limit withdrawals to $2 million or 15 percent of the participants’ money, whichever is greater, or charge a withdrawal penalty.

After the fund reopened Dec. 5, Alex Sink, the chief financial officer for the state, said in a written statement that officials were pleased by the “level of support” from investors regarding the pool and hoped “to see progress in getting the [Local Government Investment Pool] back on the proper footing.” He also encouraged those that had pulled their money out last month to return to the pool.

Mr. Hawkins said he was planning to withdraw the Holmes County district’s full $2 million allowed when the pool reopened, but was also concerned about whether the district would have enough cash flow in June when the time comes to cut large “summer checks” for 10-month employees.

By then, he said, “hopefully, they will have resolved some of the issues.”

School districts have been left feeling wary about the state’s handling of taxpayers’ money.

“Generally, it was considered a very safe and secure place to put the money,” said Leanne Evans, the treasurer for the 168,000-student Palm Beach County district, which withdrew all of its $300 million from the pool on Nov. 2 and immediately reinvested it in a less risky fund.

“I’m willing to take a lesser return,” she said, “to make sure we have the money to pay teachers’ salaries and educate the kids.” Problems in one state likely to prompt renewed scrutiny of similar pools

Vol. 27, Issue 15, Pages 14,17

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