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Supervisors seek probe of investment pool losses

by Dave Boyce

With local school districts and other agencies in the county having lost a total of $155 million from the recent collapse of Lehman Brothers investment bank, the Board of Supervisors is seeking an outside analysis of decisions made in the county treasurer's office and of the policies and practices for the county's investment pool.

The five-member board gave its unanimous approval on Tuesday, Nov. 4, to a resolution that authorizes the county manager to solicit proposals from financial advisers for "an independent perspective" on the treasurer's office decisions in the months leading up to the Sept. 15 Lehman bankruptcy.

The board voted after hearing from and questioning Treasurer Lee Buffington. Responding to criticism that school districts had been unaware of the pool's stake in Lehman securities, Mr. Buffington acknowledged not having kept them in the loop. "I'll take full responsibility for that," he said.

As for Lehman, it was "a perfect storm," he added. "It just doesn't happen. We've been doing this for 23 years. Nobody's lost any money prior to this point. ... The situation with Lehman was such a surprise to everybody. The big guys are in the same boat we were."

Some school districts lost millions. The Sequoia Union High School District took a $6.5 million hit, about 7 percent of its $92 million annual budget. The Menlo Park City School District lost $3.5 million, or 14 percent. Other local districts lost between 1.3 and 2.3 percent.

The schools had been cutting back and boosting reserves in anticipation of a bad budget year, County Superintendent of Schools Jean Holbrook told the board. "Those funds and more have now been eroded," she said.

"Taxpayers in San Mateo County have generously supported bonds to finance building and renovation that are sorely needed," she added. "The projects promised to citizens will now need to be scaled back and in some cases eliminated. Taxpayers will be making payments on millions of bond dollars for the next 25 years with nothing to show for it."

The county Office of Education has hired its own counsel and forensic accountant to investigate the treasurer's handling of Lehman securities, Ms. Holbrook said. A report is due before the end of the year.

Some fraction of the losses could be recovered. The county is a participating creditor in Lehman's bankruptcy proceedings. Lehman creditors may recoup something from the government bailout of the financial services industry. And the county is suing Lehman officers and directors for misleading investors.

An avoidable mess?

In an office responsible for a $2.7 billion portfolio, the tools at hand seem appropriate. The office subscribes to Bloomberg Professional, a service used by "central banks, investment institutions, commercial banks, government offices and agencies, law firms, corporations and news organizations in over 150 countries," according to the Bloomberg Web site.

Other sources include the Wall Street Journal, the New York Times, Barron's, and CNBC economists, who appear several times a day, Mr. Buffington told the board. "It's (also) not unusual for us to pick up the phone and ask somebody that we respect what the situation is," he added.

The office monitors ratings reports for the pool's securities, consults with three economists twice a year, and re-prices the portfolio daily, a process called mark-to-market.

Given the rescues of investment bank Bear Stearns and mortgage banker Countrywide Financial earlier this year, Lehman was a concern, but Mr. Buffington said he drew some comfort from its rejection of a possible takeover by the Korean Development Bank shortly before the Sept. 15 bankruptcy.

Selling Lehman at that time would have cost the pool about $30 million, he said. He didn't, he said, thinking of Lehman as too big to fail, that Bank of America would take it over and that, in any case, the U.S. Treasury would make note holders whole. "There was a good chance that we would not have had any loss at all," he said.

But BofA bought Merrill Lynch instead, and Treasury Secretary Henry Paulson denied Lehman a rescue.

Supervisor Jerry Hill asked Mr. Buffington repeatedly about the first of three objectives for managing public funds, set by law and in order of priority: safeguard the principal, satisfy the liquidity needs of depositors, and achieve a return.

"Looking for some type of rescue, is that consistent with preservation of capital," Mr. Hill asked.

"Yes, I think so," Mr. Buffington replied. "The Lehman bonds themselves were pretty steady."

Now what?

The supervisors' resolution includes amendments by Supervisor Mark Church to include testing the value of the portfolio in simulated stressful markets, and a considering the idea of multiple portfolio managers.

Mr. Church asked about diversifying the pool away from financial sector securities.

The problem with that approach, Mr. Buffington said, is that the county needs cash to pay bills year round and financial sector debt is about four times more available than the more desirable industrial sector debt.

"We would love to be able to get more industrial stuff if we could," he said. "They just don't come to market that often and we have a continuous need."

Also unhelpful: the number of firms offering debt that meets state quality requirements is dwindling rapidly, he said.