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Falling interest rates hurt Missouri's investment portfolio

Wednesday, December 17, 2008 | 4:41 p.m. CST; updated 9:13 p.m. CST, Wednesday, December 17, 2008

JEFFERSON CITY — It may be cheaper now to take out a car loan. But the declining interest rates designed to spur lending and make it more affordable for consumers to buy big-ticket items also have battered the state's investment portfolio.

For the most part, that's OK with the mangers of Missouri's portfolio, who are more focused on not losing money than returning huge profits.

The constitution allows a portion of Missouri's coffers to be invested in highly rated short-term securities. That basically makes the state a fixed-income investor, just like many senior citizens if they had more than $3 billion to invest.

The state puts its money in commercial paper, U.S. treasury securities, the debt of U.S. government agencies, standard bank certificates of deposit, certain mortgage backed securities and overnight loans to banks.

Each of these investments depend on interest rates to return a profit. That makes them less susceptible to the whims of Wall Street, unlike mutual funds, but means Missouri's investments are more vulnerable to the decisions of the Federal Reserve.

And the Fed has been dealing with a recession by slashing interest rates to boost lending and jolt consumer spending. On Tuesday, the Fed announced it had reduced the federal funds rate, the interest that banks charge each other, to a range of zero to 0.25 percent. That is down from the 1-percent target rate in effect since the last meeting in October.

The lower interest rates have caused Missouri's investments to take a hit.

For the 2009 fiscal year that started July 1, the state has a 3.11-percent return on its investments. That would be the lowest return since 2005, which marked the start of an upswing after several years of declining yields through the beginning of the decade.

"Yield in this kind of market, in this credit crisis, is the last consideration,'' said Mark Mathers, the director of investments in the state treasurer's office. "Our first priority is going to be the safety of the portfolio, and the second consideration is going to be liquidity, and yield really comes last.''

Only a small portion of the billions of dollars spent by the state each year depend on investment income. Last year, the state's budget called for $21 billion in spending. So the roughly $195 million earned by investing that year accounted for less than 1 percent of the entire budget.

The search for security has helped keep Missouri away from the "commercial paper'' investments that have gotten government investors from Washington state to Florida into trouble.

Commercial paper is the short-term debt firms use to pay everyday expenses such as payroll and supplies. Investors buy the debt and earn interest on it, but if the company that issued the commercial paper goes out of business, it can be difficult for the investor to get any money back.

As recently as January, commercial paper accounted for almost 15 percent of the nearly $4.5 billion Missouri invested. By Nov. 30, it shrunk to less than 3 percent of the total portfolio. Instead, the state took on more debt issued by government agencies such as the Federal Farm Credit Bank and the Federal Home Loan Bank.

Mathers said the treasurer decided in late 2007 to stop buying commercial paper from the banking and insurance sector and only buy it from Fortune 500 companies, because the state had concerns about the insurance and financial sector and worries about liabilities that did not appear on the companies' books.

"We were concerned about the lack of transparency and off-balance sheet liabilities,'' he said. "We viewed it as a very volatile sector of the economy.''

Not everyone got out so quickly.

A prime example of the potential problem with commercial paper is Mainsail II, which was run by the British hedge fund Solent Capital Partners LLP to borrow money. Connecticut, Florida, Maine, Montana and a Washington county each bought commercial paper from Mainsail II, but the rating for the investment slipped from the highest to junk within weeks. Later, the assets of Mainsail II were frozen.

To free $20 million it invested in that commercial paper, Maine reached an agreement with the broker that sold the investment to repay the funds.

The recession and breakdown in the stock and financial markets has ensnared pension funds, public employee retirement funds and left state treasurers and investors scrambling to stay ahead.

Pam Taylor, the executive director of the National Association of State Treasurers, said its members have been holding regular nationwide conference calls since the beginning of October. The Kentucky-based trade group for state investment officials also has had speakers focus on short-term investing and state pension funds at two national conferences in 2007.


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