Thursday, December 6, 2007

Will State SIV Funds bankrupt local communities?

Many states are hiding a deep dark secret; they have been running investment funds that have bet heavily on mortgage-backed derivatives. Hiding behind financial confidentiality; many government officials loath to discuss the impending crisis. Significant portions of the money placed in these state funds comes from local governments who have been urged to allocate money in these vehicles in order to earn higher returns. Now the wheels are coming off.

The recent situation in Florida is a standard run on the “bank”. Very jittery local governments basically rushed the gate to remove money from the state fund over several days until officials shut down withdrawals on January 29th. Today the fund re-opened up to limited withdrawals of up to 13% of assets limited to $2 million. Action was described as brisk as many communities sought to recover something from the pending fiasco.

The local governments have every right to be nervous; currently many of these state funds are probably only worth only 30% of their “face-value”, as a continual cycle of downgrades hit their mortgage-backed SIV investments. Many local communities rely on these funds to pay pensions and operating expenses. A crisis in these state funds would leave many government retirees out in the cold and communities unable to meet payroll.

States such as Connecticut, Maine and Montana are experiencing similar scenarios with local governments rushing the gate for withdrawals, the quarantining of troubled fund components, and more than 20% of some funds being declared as defaulted SIV investments. The state government officials have moved to the defensive in recent days making statements that they expect the funds to “recover” and that state reserve funds can cover any contingent shortfalls.

So much for proper stewardship, most of these vehicles were sold to the state financial oversight boards as “safe” investments that would earn higher interest. Of course, Wall Street reaped exceptional fees for their involvement in these entities while hiding the actual risk involved from these government entities.

At this point, it is simply a question of how deep and painful the fallout for local governments will be rather then a question of if the downside SIV scenario will occur.

Fund Crisis in Florida Worrisome to States