While the downgrades of the bond insurers threatened U.S. municipalities with higher future interest costs, it became obvious in November 2007 that there were far more immediate risks to public finances when there was a run on Florida's Local Government Investment Pool . The run began when word got out that the Investment Pool had exposure to $1.5 billion in defaulted and downgraded SIVs. Florida had to freeze withdrawals to prevent the fund from collapsing. The municipalities that got out early were lucky, all others had to find emergency funding to meet their payrolls for police, firemen, hospital workers, teachers, and other employees.
Local, State and Government investment pools existed in at least 20 states and were essentially special money market funds that bought short-term debt and were set up to get higher yields that would otherwise have been available. Little did they know that these slightly higher yields were being produced by taking on massively higher risk through exposure to subprime toxic waste that the big brokers (Lehman in Florida's case) were more than willing to sell to them. Problems were by no means isolated to Florida either. In the last days of November, Montana school districts, cities and counties withdrew 10% of the total $2.4 billion in its investment fund after the rating on one of the pool's holdings was lowered to default. The state of Maine had invested 3% of it money, apparently on Merrill Lynch's advice, into a fund only two weeks before its credit rating was lowered to junk status. Financial difficulties with government investment pools were also reported in Orange County, California and Seattle, Washington.
While the losses of the Government Investment Pools were certainly serious, were they isolated of were they likely to spread? If these ultra-sophisticated money-market funds got into trouble, wouldn't it be reasonable to assume that the money market funds open to the individual investor might suffer similar problems in the future? By the late fall of 2007, it had already been reported that Bank of America, SunTrust, Wachovia and Legg Mason had taking steps to prop up money market funds that contained securities of possibly questionable worth. And it looked like the formerly safest of investments were in some cases becoming among the riskiest.
Next: Subprime Freezes Over
Organizer, New York Investing meetup
For more about the New York Investing meetup, please go to our web site: http://investing.meetup.com/21