The collapse last month of a Florida securities firm, which triggered the banking crisis in Ohio, could cost one of the nation’s largest school systems as much as $8 million.
The Memphis school district, as part of an aggressive investment policy it began some four years ago, had four short-term investments of $2 million each in pension funds in esm Government Securities Inc., of Fort Lauderdale, on the day it was closed by a court order, Ray Holt, the district’s deputy superintendent, confirmed last week.
According to Mr. Holt, the district has a current operating budget of more than $250 million and reserve accounts of about $8 million. “Obviously, this would be going against our reserves,” he said. “We’re not going to have to close school early or not meet the payroll, but it will have a long-term financial impact.”
Mr. Holt also said he was optimistic that the district would recover some of its losses. Pending bankruptcy proceedings, the district is re-evaluating its investment program, to see if it should be “more conservative,” he added.
According to a lawyer for esm’s court-appointed receiver, Memphis was the only school system among the many municipalities and thrift institutions that had investments in esm, whose collapse led to the failure of the Home Savings Bank of Cincinnati and the subsequent temporary closing of 71 state-insured savings and loan institutions in Ohio.
Altogether, the investors could lose up to $200 million, said the attorney, Mark Raymond.
Other school systems have also been caught in recent years with short-term investments placed with investment firms that have gone bankrupt, including Lion Capital Group and rtd Securities Inc, two Manhattan-based companies. Their losses prompted warnings from the New York State Comptroller about the type of transaction Memphis was engaged in. (See Education Week, May 23, 1984.)
Last week, three firms associated with a New Jersey-based financial group, Bevill, Bresler and Schulman, also either filed for bankruptcy or were ordered closed, leading to renewed calls for government regulation of the industry. No school districts are known to have been among Bevill’s creditors, according to the U.S. Bankruptcy Court in Newark.
Invested in ‘Repos’
The $8 million that Memphis stands to lose was invested in esm through a complex financial device known as a “repo,” or repurchasing agreement.
A repo is a form of short-term borrowing, in which the lender buys a batch of securities in return for the seller’s promise to repurchase the securities later at a higher price. The securities serve as collateral, and the higher repurchase price compensates the buyer for the use of the funds. According to Mr. Holt, Memphis purchased mostly Treasury notes from esm
Jeffrey B. Noss, vice-president and manager of municipal research at Roosevelt and Cross Inc., a New York City investment firm, said that school districts invest in repos because they typically offer “a little more yield” than other investment opportunities.
The difference can range from one-tenth of a percent to as much as three-quarters of a percent, he said.
Repos, themselves, are a legitimate, highly secured form of borrowing, Mr. Noss said, but they can be manipulated by fraudulent dealers. Because the industry is not regulated, such dealers are hard to spot.
Unknown to the Memphis school district, esm had been overextended for years, but kept going, apparently accumulating fresh securities through so-called “reverse repos,” and then trading them for cash.
By 1980, esm had accumulated losses of $92.8 million, compared to assets of little more than $30 million, according to The New York Times.
esm was finally closed down on March 4 after failing to make good on a loan issued to it by a Miami savings and loan. The Securities and Exchange Commission sought the court order that closed the firm, accusing it of fraud.
Like many large districts, Memphis routinely invests its idle funds in short-term securities. Prior to the collapse of Lion Capital, many states encouraged such investments by loosening the traditionally rigid controls on public monies, so that municipalities could cash in on lucrative interest rates.
Common Practice
According to Mr. Holt, such transactions are handled “every day” by the district’s finance department. “We had $68 million invested short-term on the day esm went down,” he said.
In the last four years, the Memphis district’s investments have netted it some $22 million, Mr. Holt said, compared with $9 million the previous four. Part of that difference, he noted, has resulted from generally high interest rates.
Memphis had invested in esm for about two years prior to its collapse, Mr. Holt said. “They called us and said they were doing business with others in Memphis,” Mr. Holt said. “They sent us the appropriate information and we checked them out.”
Suits Considered
According to Mr. Raymond, esm’s creditors should recoup “a pretty damn good portion” of their losses. The receivers have recovered about $30 million of esm’s assets and expect to uncover more, he said.
Formal bankruptcy proceedings are expected to begin in the next few weeks, according to Charles Burson, an attorney hired to represent the school district after esm collapsed.
But it could be years before Memphis gets any of its money back. Tracing the failed firm’s assets could continue for two years, Mr. Raymond said, and litigation could drag on for another two years.
The school districts caught in last year’s collapse of the New York securities firms are going through a similar proceeding, attempting to recoup some $47 million.
Aside from seeking recovery in the bankruptcy proceedings and attending meetings of the securities firm’s creditors, the Memphis district is also considering lawsuits against other entities involved with esm, Mr. Burson said.
“We’re still receiving information,” he said. “As soon as we digest that information, we’ll make our moves.”
