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Quiet Deals Preceded Run On State Fund

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By DAVID EVANS, Bloomberg News

Published: December 20, 2007

It was the first day of November and Coleman Stipanovich's world was coming undone. Florida school districts and towns had begun pulling their cash out of the $26 billion money market fund he supervised after they learned it held subprime-tainted debt.

Stipanovich, who earned $180,000 in 2006 as executive director of the State Board of Administration, was in New York in confidential meetings with Lehman Brothers Holdings Inc., the largest U.S. underwriter of mortgage-backed bonds. Lehman was proposing ways to help the state manage the risk of its debt investments, according to a letter the bank sent to Stipanovich after the meeting.

What Stipanovich hadn't told his boss, Florida Chief Financial Officer Alex Sink, was that Lehman Brothers was the same firm that had sold the state fund $842 million in mortgage-backed debt in July and August. Those securities defaulted within four months, and totaled more failing debt than any other bank sold the state, Florida records show. "At the time, I never knew it was Lehman Brothers that actually sold us these investments," Sink said.

Sink also was unaware that former Gov. Jeb Bush, who incorporated Jeb Bush & Associates in February, a month after completing his second term, had been hired as a consultant to Lehman Brothers in June.

'Do Something Quickly'

In November, school districts and local agencies that kept their cash in the state pool rushed to withdraw $12 billion, or 46 percent, of the money in the fund. On Nov. 29, the state froze the fund to stop all withdrawals. "If we don't do something quickly, we're not going to have an investment pool," Stipanovich told the board that day.

Until November, the Florida pool was the largest public money market fund in the United States. It held cash for about 1,000 school districts, towns and local agencies in Florida.

Stipanovich, who resigned Dec. 4, declined to comment for this article.

Sink is riled up about more than Stipanovich. She says JPMorgan Chase & Co. and Lehman Brothers were offloading tainted debt on Florida and other states at a time when those assets were plummeting in value.

The subprime meltdown made front-page news in June. During the next two months, Wall Street firms were quietly peddling mortgage-backed securities to the states.

And the states, eager for higher returns, were buying them.

"Lehman and the other big players in the market decided they didn't like this stuff in their own accounts," Sink said. "Where did they drop it and who did they dump it to? It looks questionable to me."

Joseph Mason, a former U.S. Treasury official and now a finance professor at Drexel University in Philadelphia, said Wall Street had few takers for its subprime-tainted debt. "When they couldn't sell it to more-sophisticated investors, they found less-sophisticated investors like local government investment pools," he says.
Lehman Brothers spokeswoman Kerrie Cohen said the bank had only good intentions. "The firm's No. 1 priority is to deliver first-rate products to our clients," she said. "We are disappointed when any security that is purchased by a client underperforms expectations."
JPMorgan Chase spokesman Joseph Evangelisti declined to comment.

Florida first revealed that close to $1 billion of its money market fund investments had been downgraded by credit rating companies on Nov. 1, after a month of inquiries by Bloomberg News.

States and counties run pools similar to money market funds to hold cash for school districts and local agencies. Most states require fund managers to make only short-term investments in debt such as U.S. Treasuries, certificates of deposit and corporate commercial paper, or short-term loans.

Strayed From Guidelines

Florida and other states have strayed from those guidelines in recent years, buying commercial paper from collateralized debt obligations, or CDOs, and structured investment vehicles, or SIVs. These investments are bundles of securitized loans, often loaded with subprime debt, which is why they offer higher returns than Treasuries.

They also hold greater risk of default.

Harvey Pitt, chairman of the U.S. Securities and Exchange Commission from 2001 to 2003, said state fund managers should have been savvier. "All of this could, and should, have been avoided by careful due diligence, constant reassessment of risk and paying close attention to market trends," he said.

Sink, who sits on a three-member board overseeing the Florida pool, says she didn't learn until Nov. 28 that New York-based Lehman Brothers had sold Florida most of its now default-rated commercial paper.

Gov. Charlie Crist and Attorney General Bill McCollum, who are also on the board, declined to comment.

On Dec. 12, Sink asked the audit committee of the State Board of Administration to determine who sold the pool the risky assets, whether any rules were broken and if managers made adequate disclosure once the fund's holdings had been downgraded.

Sink is upset that when Stipanovich went to New York on Nov. 1 to meet with Lehman Brothers, she thought the bank was an independent adviser to the state.

"If there's anything that raises my hackles, it's when the executive director said he was relying on Lehman Brothers' advice, when I had suggested that we might need an independent adviser to help us figure out how to deal with these issues," Sink said.

'Significant' Risk

Two years ago, Florida's pool held safer debt investments. On Sept. 30, 2005, 25 percent of the pool was invested in U.S. Treasuries and debt issued by U.S. agencies, the safest and most liquid debt sold. The rest was in short-term corporate commercial paper. Interest rates were low, and fund managers for about 100 such pools nationwide wanted higher yields.

The state gave Stipanovich and pool manager Michael Lombardi financial incentives of up to 8 percent of their annual salaries if they could increase returns for the state's pension fund.

Stipanovich, who ran the State Board of Administration, which manages $184 billion, was hired in 2000. He is the brother of J.M. "Mac" Stipanovich, a former political adviser to then Gov. Jeb Bush. Two of Coleman Stipanovich's three personal references came from top Bush aides.

Stipanovich, a Michigan State graduate, became a stockbroker and then a branch manager at Paine Webber & Co.'s Tampa office in 1986.

In August 1992, he settled a complaint filed against him by Florida's Division of Securities and Investor Protection. The agency found that, as a Paine Webber branch office manager, he failed to supervise a broker who sold unsuitable, money-losing investments to two retired cigar-factory workers.

Stipanovich left Paine Webber five months later to open his own investment company. It was dissolved in 2000 after Florida hired him.

The state promoted Stipanovich to executive director in 2002, overseeing management of Florida's pension fund and investment pool.

Jeb Bush, Consultant

In June, Bush and his new company won a consulting contract from Lehman Brothers, according to Lehman spokesman Randall Whitestone, who declined to say how much Bush is being paid.

In July and early August, Lehman Brothers sold Lombardi $603 million of commercial paper.
Lehman Brothers spokeswoman Cohen says there's no link between Bush and Lehman's sale of debt to Florida. "Bush is a member of the Lehman Brothers private equity advisory board and his company has been retained by the firm for consulting and advisory services," she said. The former governor declined to comment.

Craig Holman, of Washington-based nonprofit public interest group Public Citizen, disputes Lehman Brothers' view. "That defies credibility," said Holman, who lobbies for ethics in government. "It's a clear conflict of interest. Bush is a consultant to the company selling bad investments to the same agency on which he served as a trustee until January."

Countrywide's downgrade, and the decision to continue holding the debt, wasn't communicated to the pool trustees. Sink said it should have been. "Absolutely," she said. "That's why the executive director isn't the executive director anymore."

On Aug. 21, Sink's office asked Stipanovich if the pool's CDOs faced subprime risk. "None of these CDOs are backed by subprime mortgage loans," Stipanovich wrote in an e-mail reply the next day.

State records show the pool owned $234 million of paper issued by Buckingham CDO III on that date, holding 40 percent subprime collateral. "I think we were asking a lot of the right questions," Sink said. "We just weren't getting the right answers back."

For those running the Florida pool, the best hope is that the audit committee can sort out what went wrong and restore the fund's credibility and financial stability. If the committee doesn't, the state might have no choice other than shutting the pool down.

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