State freezes millions of local governments' invested money
PHOENIX – The state Treasurer's Office has frozen nearly $131 million worth of state and local governments' investments in a temporary pool after a major bond firm went bankrupt.
The state government has $14.3 million in the temporary pool, and just about every government entity within Yavapai County has money in it, too – its municipalities, school districts, special districts and college.
Governments all over the state have invested $4 billion in the Local Government Investment Pool administered by the state Treasurer's Office. The treasurer invests it in corporate notes and commercial paper. A second Treasurer's Office pool invests only in government bonds and produces slightly lower returns.
The two pools represent an opportunity for local governments to increase their investment power and have the state Treasurer's Office's three portfolio managers keep a close eye on the investments. Also, the local governments normally can pull out their money with only one day's notice.
The Local Government Investment Pool owned $131 million worth of the bond debt from National Century Financial Enterprises when the company filed for bankruptcy Nov. 18, after the FBI initiated an investigation into accusations of fraud and Moody's Investors Service slashed its AAA bond rating by 12 points. The company failed to make $8.3 million worth of interest payments to investors on Dec. 1.
National Century's trustee, Bank One, has accused it of "systematic financial trickery." And the company's major underwriter, Credit Suisse First Boston, wrote off $214 million, or 83 percent of its holdings, in late November while accusing National Century of "massive fraud."
The state segregated the $131 million from its main pool on Nov. 22, to avoid a run on the pool. The $131 million represents 3.2 percent of the main pool. Local governments can't withdraw their money from the temporary pool now, and no one wants to buy the bonds from the state pool now anyway.
State Senate Majority Leader-elect Ken Bennett, R-Prescott, doesn't think the state government's frozen $14 million will cause it any extra trouble as it struggles to get its budget back into the black early next year.
No one knows at this point if fraud has left the company unable to pay off its investors in part or full.
"I think they'll eventually recover most, if not all, of the money, but it may take some time," Bennett said.
State Treasurer Carol Springer, who also calls Prescott her hometown, noted that the company bought medical bills from hospitals at 80 cents on the dollar, packaged the bills into bonds, then recovered the full 100 percent from Medicare and Medicaid. So unless someone in the company has stolen massive amounts of money, the pool should eventually get its money back.
"Hopefully over time we will recover that," Springer said. "It's going to take some time." The state just got all its money back from a similar bond company failure after waiting 20 years, Springer said.
Since the frozen temporary pool amounts to only 3.2 percent of the main pool's investments, "It shouldn't cause any sort of major financial distress for any of the participants," Springer said.
Her office didn't see the problem coming, Springer said, noting that a company can't get any better rating than AAA.
"We've had it for quite some time and it's been doing very well," she said of the National Century investment. "This happened like overnight. There's nothing we could do to prevent it or lessen the loss."
National Century's bonds paid higher yields than other bonds in the state pool, yielding 2.33 to 2.54 percent in October versus the entire pool's yield of 2.17 percent.
Some local government officials don't predict as rosy an outcome as state officials.
"My optimism is pretty low," Sedona City Manager Eric Levitt said. "I don't expect we'll ever see all of it back." Sedona has the most money of any Yavapai County municipality in the temporary pool, at $1.1 million.
The Yavapai County Treasurer's Office invests the money of every school district and special district in the county in the Local Government Investment Pool. They now have a combined $2.4 million locked into the temporary pool.
"I don't think anybody's lost any money yet," Yavapai County Treasurer Ross Jacobs said.
But he's not taking any future chances, deciding Tuesday to take all the remaining $72 million of the county's pooled money out of the Local Government Investment Pool that invests in corporate notes and commercial paper, and switching it to the lower-risk state pool that invests in government bonds.
"If you take one hit like this, it just isn't worth it," Jacobs said.
That news worries Levitt, who wonders if other governments will follow suit and switch pools.
"That concerns me to hear other entities are pulling all their money out," Levitt said. "That could create new issues." Sedona still has another $33 million in the higher-risk pool.
While she is optimistic about the state pool, Springer said she's shocked that the bond market now may be experiencing the same fraud that the stock market has seen.
"To have this in the bond market is just more bad news for the economy as a whole," Springer said. "If we have this kind of attitude by corporate officials that they can get away with this stuff, where is the investor going to go?
"The federal government needs to really clamp down on this stuff. Otherwise, investors are going to have no confidence."
Contact Joanna Dodder at firstname.lastname@example.org or 445-8179, ext. 2035.