You wondered how Florida (and other states) bought into the subprime mess....
Seller of shaky debt advised state on fund
By DAVID EVANS
Bloomberg News
Wednesday, December 19, 2007
NEW YORK — Coleman Stipanovich's world was coming undone on the first day of November. Florida school districts and towns had begun pulling their cash out of the $26 billion money market fund he supervised, after they learned that it held subprime-tainted debt.
Stipanovich, who earned $180,214 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, 58, 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 of mortgage-backed debt in July and August that defaulted within four months, more 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.
"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.
Sink, 59, also was unaware that former Florida 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.
She says JPMorgan Chase & Co. and Lehman Brothers were unloading tainted debt on Florida and other states at a time when those assets were plummeting in value.
In June, Bear Stearns Cos. disclosed that two of its hedge funds were failing because they were stuffed with subprime collateral, making the simmering credit crisis front-page news.
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."
Wall Street had few takers for its subprime-tainted debt, said Joseph Mason, a former U.S. Treasury official and now a finance professor at Drexel University in Philadelphia. "When they couldn't sell it to more sophisticated investors, they found less sophisticated investors like local government investment pools," Mason said.
At the same time, Lehman Brothers served its shareholders well in 2007, said Bruce Foerster, president of Miami-based corporate financial adviser South Beach Capital Markets. On Dec. 13, the bank reported it had limited a fourth-quarter write-down of $2.2 billion tied to residential mortgages with $2 billion it made on hedges.
The board gave Chief Executive Officer Richard Fuld a $35 million stock award for record income in 2007.
"What's not to like about a record year?" Foerster said.
Lehman Brothers had only good intentions in its sales to Florida, spokeswoman Kerrie Cohen said. "The firm's number one 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."
Stipanovich and JPMorgan Chase spokesman Joseph Evangelisti declined to comment.
Cohen also said 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 Public Citizen, a Washington-based nonprofit public interest group, disputed 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."
Crist shakes off suspicions
Florida first revealed that credit rating companies had downgraded close to $1 billion of its money market fund investments on Nov. 1.
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 withdrawals.
"If we don't do something quickly, we're not going to have an investment pool," Stipanovich told the board that day.
State fund managers should have been savvier, said Harvey Pitt, chairman of the Securities and Exchange Commission from 2001 to 2003.
"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.
Pool investors such as the Jefferson County School District, which kept more than $4 million in the state fund, were left scrambling to pay their teachers.
Hal Wilson, the school board's chief financial officer, stopped checks to vendors to ensure that the district's 220 employees could cash their paychecks. "It has been stolen from our local taxpayers because we entrusted their money with the state and our elected officials assured us it was safe," Wilson said.
On Nov. 30, state officials hired New York-based investment management firm BlackRock Inc. to study the fund's holdings and recommend a plan. On Dec. 4, BlackRock reported that about $2 billion of the pool's holdings were in default or had significant credit risk.
It recommended that the state put 86 percent of its remaining $14 billion of assets that had no risk of loss or default in what it called Fund A. The remaining 14 percent of distressed assets would go into Fund B and stay frozen.
Two days later, the state allowed limited withdrawals from Fund A. Local districts withdrew $1.8 billion in the first three days after the state lifted the freeze.
Sink, who sits on a three-member board overseeing the fund, said she didn't learn until Nov. 28 that New York-based Lehman Brothers had sold Florida most of its now default-rated commercial paper.
Attorney General Bill McCollum, who with Gov. Charlie Crist is also on the board, declined to comment.
Sink said she had believed Lehman Brothers was an independent adviser to the state. On Dec. 12, Sink asked the audit committee of the State Board of Administration to determine who sold the pool the assets now in Fund B, whether any rules were broken and whether managers made adequate disclosure once the holdings had been downgraded.
Stipanovich was hired in 2000. Two of his three personal references came from then-Gov. Bush's top aides.
"An outstanding individual capable of significant contributions to the board," Sally Bradshaw, Bush's chief of staff, wrote about Stipanovich.
Stipanovich resigned Dec. 4.
Crist, who has been a state board trustee since 2003, also has enjoyed a close relationship with Lehman Brothers. A Lehman Brothers managing partner was a featured speaker at Crist's two-day summit on climate change in July. And Crist met with top officials from the company when he was in New York this month to raise money for his campaign to support a property tax constitutional amendment. Crist also considered a proposal this year to lease the state lottery to the company.
Palm Beach County School Board Chairman Bill Graham said, "That just gives the appearance of impropriety." The school board pulled $509 million from the state fund in November.
But Crist, who as attorney general sued the company in 2003, claiming it helped finance predatory lending, said that conclusion is "just wrong."
Crist said Tuesday that he was not aware Lehman Brothers sold the state any questionable securities. He also said his relationship with the company wouldn't prevent the state from looking into the deals.
"I don't give them the benefit of the doubt," he said. "It's not my style to do that. Nor is it my character to do that."
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