"Folks have always thought the State Board of Administration was a safe investment. Some thought it was backed by the state, but that’s not the case and they are subject to market risk.”—Broward County Commissioner John Rodstrom on Florida’s state operated Local Government Investment Pool.
In my November 27 post explaining the meaning of the December 11, 2007 Jupiter/Pluto alignment’s effects on financial markets (“Foreign Band-Aid”), I mentioned that the last time these two planets aligned, Orange County California defaulted on its municipal bonds.
Jupiter conjunct Pluto represents large sums of money pooled together to invest in debt instruments. Pluto relates to things that are hidden and not what they appear to be at face value. So it comes as no surprise that as these planets align in the global sign Sagittarius that reports are surfacing of local governments from Norway to Florida affected by opaque securities sold by Wall Street.
The Local Government Investment Pool (LGIP) is an investment pool money market fund run by the state of Florida that local governments invest their surplus tax receipts in to pay for day to day operations. When word got out that the fund contained $2.28B of mortgage-backed securities and commercial paper downgraded by the ratings agencies in the last month, local governments withdrew almost $10B in two weeks. Yesterday Florida’s State Board of Administration froze withdrawals at least until the board meets on December 4.
The Financial Times is reporting that Lehman Brothers (LEH) sold most of the securities to the fund. These securities consisted of mortgage-backed securities issued by Countrywide (CFC), SIVs issued by Axon Financial Funding and Harrier Financial Fund, and asset-backed commercial paper issued by Kohlberg Kravis Roberts (KKR) affiliates KKR Pacific and KKR Atlantic.
The Board of Administration issued a statement yesterday that the securities continue to pay back the principal and interest. Since the investments no longer meet the fund’s guidelines of investing in “short-term, highly rated government and non-government securities”, administrators would like Florida to buy $1.5B in credit insurance on the investments. It seems to me that the fund’s best course of action would be to wait for these short-term downgraded securities to mature. Otherwise a continued run on the fund will result in a fire sale of the securities.
As Sir John Templeton has said, “The four most expensive words are ‘this time it’s different.’” Cycles repeat themselves and it is up to us to learn and understand the message they convey. Two big themes emerge here:
1. It is baffling that local governments failed to understand the risks involved in this fund. Due to the freeze, Jefferson County school district is having to negotiate a short-term loan with a local bank to make payroll. But Larry Tibbs, Lauderdale Lakes’ finance director, says the city is still invested in the LGIP. “It’s kept a 5% interest rate.” Five percent! You’ve got a fund invested in what’s now viewed as toxic by many and it only pays five percent interest? Local governments could get that rate at a bank!
2. It is the overly accommodative policies of central banks in keeping interest rates way too low for too long that creates these financial crises in the first place. People buy homes and other items they cannot afford, only to end up losing them after the bubble bursts. Investors and governments, seeking to get a better return on their investments, take inappropriate risks. When it all ends badly, everyone is shocked and knows nothing.
RELATED POST: “Foreign Band-Aid” (in the Economy section of the Directory).
Referenced Newspaper Articles:
Financial Times: “Florida Moves to Stop Run on Fund”
Also: “How ‘safe’ state fund ran into the rocks” (print edition, page 8)
Sun-Sentinel: “State freezes ‘Run on the bank’ at investment fund”
Wall Street Journal: “Florida Fund Feels Credit Pinch” (print edition, page C2)