The debacle in Florida, namely a $27 billion short-tern investment fund being frozen after the revelation it held $700 million of defaulted debt (today reported as $900 million) led to $12 billion in withdrawals, is producing a cash crisis at the government entities that hadn’t gotten their money back.
Aside from the troubles this impairment is creating in and of itself, it will feed “run on the fund” behavior if any other government-operated funds encounter similar difficulties.
From Bloomberg:
School districts, counties and cities across Florida are scrambling to raise cash after being denied access to their deposits in a $15 billion state-run investment fund.
Florida’s State Board of Administration, manager of the Local Government Investment Pool, halted withdrawals yesterday at an emergency meeting after $12 billion was pulled out this month from participants. Governments from Orange County, home of Disney World, to Pompano Beach asked for their money back following disclosures that the fund held $1.5 billion of downgraded and defaulted debt.
“The unthinkable and the unimaginable have just happened here in Florida,” said Hal Wilson, chief financial officer of the Jefferson County school district, which kept its entire $2.7 million of cash in the fund. “What we just experienced here is a classic run-on-the bank meltdown.”
Thousands of school districts, towns and fire departments 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 Treasuries and certificates of deposit from highly rated banks.
By freezing the Florida fund, officials left governments without ready access to cash they are accustomed to drawing upon for routine expenditures. The pool was the largest of its kind in the U.S. at $27 billion before the unprecedented withdrawals.
Just 30 miles (48 kilometers) east of the state capitol in Tallahassee, there was no money to pay the 220 teachers and other employees in Wilson’s Jefferson County school district today. Wilson said he trusted the State Board of Administration’s assurances that the money was safe even as other pool participants withdrew billions of dollars.
“We are in the process of working out provisions of a short-term loan with our bank to cover the overdrafts that will occur in our payroll account today,” Wilson said….
Standard & Poor’s yesterday said it contacted state officials about whether the fund holds any money for debt service payments by local governments and whether that cash will be made available. The credit-rating company said it hadn’t yet received information and was monitoring the situation….
The board is considering ways to shore up the fund, including obtaining credit protection for $1.5 billion of downgraded and defaulted holdings hurt by the subprime market collapse. In voting for the suspensions, officials sought to stem the flood of money leaving the pool and avoid losses on forced sales of assets…
The fund’s $900 million of asset-backed commercial paper that was downgraded to default amounts to 6 percent of its assets. Another $650 million, or 4 percent, is invested in certificates of deposit at Countrywide Bank FSB, a unit of Countrywide Financial Corp. The bank’s rating was cut to Baa1, three levels above junk status, by Moody’s Investors Service on Aug. 16.
Update 11/30. 6:00 PM: Other states are seeing removals from their cash funds. MarketWatch reports that roughly 10% has been withdrawn from its vehicle.
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Im telling you dudes, look at ERISA exemptions that allow swaps transactions using pension collateral! Sounds impossible, but look at the linkage between Florida general funds and subprime CDOs; although they are not sitting on lots of junk, this type of disclosure is going to expose the reality of yield enhancement insanity linked to subprime defaults!
This is such a huge area to unwind, as very few people really understand it, just like pre-Enron!
Re:
Massachusetts Financial Services Company, d/b/a MFS Investment Management (“MFS”), a Boston-based investment management company, will perform certain advisory and administrative functions with respect to the Collateral pursuant to a collateral management agreement to be dated as of the Closing Date (the “Collateral Management Agreement”) between the Issuer and MFS (in such capacity, the “Collateral Manager”). See “TheCollateral Manager” and “The Collateral Management Agreement.” Under the Collateral Management Agreement, the Collateral Manager will manage the acquisition and disposition of the Collateral Debt Securities, including exercising rights andremedies associated with the Collateral Debt Securities, disposing of the Collateral Debt Securities and certain related functions. The Collateral Manager has advised the Issuer that it or one or more of its affiliates expects to purchase 1,000 Preference Shares. See “Risk Factors—Certain Conflicts of Interest—Conflicts of Interest Involving the Collateral Manager.”
Please be patient, as I know this has been annoying, but hang in there, as Im getting closer!
Re: August 2006 – Landmark pension reform legislation passed last night by Congressand expected to be signed by the President this month includes the most significantchanges to the fiduciary provisions of ERISA since its enactment in 1974. The new legislation (the “Pension Reform Act”) significantly relaxes the rulesgoverning when asset-backed securities (“ABS”), including commercialmortgage backed securities (“CMBS”) and collateralized debt obligations(“CDOs”), may be offered to investors holding certain types of retirement planassets.Absent an exception, issuers of ABS, CMBS and CDOs that are not structuredas debt must comply with ERISA, including its stringent fiduciary and prohibited transaction rules — which is not practical for most ABS, CMBS and CDO issuers. One regulatory exception (known as the “SignificantParticipation Exception”) relied on by many issuers of either below-investmentgrade ABS, CMBS and CDOs or ABS, CMBS or CDOs that are notcharacterized as debt for tax (each of which typically cannot be characterized asdebt for ERISA purposes) applies if an issuer does not have “significantparticipation” by “benefit plan investors”.
http://www.mayerbrown.com/cdo/publications/article.asp?id=2901&nid=3655
Thanks for hanging in there for this Subprime-linked issue; somewhat related to Florida bond illiquidity:
President Bush Signs Pension Reform Act (8.17.06)
Mortgage Issuance Up in First Half of 2006; ABS Issuance
President Bush Signs Pension Reform Act
The Asset Managers Division is pleased to report that President George Bush signed the Pension Reform Act which modernizes the Employee Retirement Security Income Act (ERISA). Of particular note, the new pension legislation includes a prohibited transaction exemption for cross-trading between separate pension accounts held with the same money manager and boosts the level of ERISA assets that can be invested in investment vehicles such as hedge funds. Association staff, in conjunction with AMD leadership and its members, worked closely with Congress on this part of the legislation.
President Bush Signs Pension Reform Act; Cross Trading Exemption Included
President Bush this week signed the Pension Reform Act (H.R. 4), comprehensive pension legislation that represents a significant overhaul of the prohibited transaction provisions of the 32-year old Employee Retirement Security Income Act. H.R.4 is Public Law No: 109-280. The changes include a prohibited transaction exemption for cross-trading between separate pension accounts held with the same money manager and boost the level of ERISA assets that can be invested in investment vehicles such as hedge funds. Under the legislation, cross-trading would be allowed for private pension plans with at least $100M in assets, resulting in lower transaction costs for pension plans.
Yves, a couple weeks ago I commented that the risk of bank runs should not be discounted and underestimated. Granted, the Florida fund run was a “bank run” per se, but still, people who were quick on the uptake were able to get their money out of the Florida fund in time. The people who trusted the authorities and chose “not to panic” are now left holding the bags.
News like this get internalized by people reading the newspaper. Next time they get a whiff of their local bank in trouble, lines will form around the corner.