First “run on a bank” sighted

At least in the US. Branches of Northern Rock were where the first official runs took place, but the Northern Rock is UK based. And this case isn’t exactly a bank, but it might as well be (particularly if you are a local government in Florida).

great-seal-of-the-state-of-floridaThe State of Florida runs an investment pool for its local governing bodies, and that pool just so happened to toss a lot of cash into a structured investment vehicles. “Structured investment vehicle” is a fancy way of describing a pile of commercial paper with a few odds and ends thrown in to enhance returns. The odds and ends are generally all the paper nobody still breathing would buy for more than a nickel on the dollar if marketed to them directly. These structured investment vehicles have taken a nasty hit to their credit ratings, and true value is in question.

As a result, all those local governments are taking no chances – they are withdrawing their money in droves. By droves I mean the following: two weeks ago the fund had $27 billion in it – as of this morning, the tally stood at around $19 billion.

I’d call average capital withdrawals of 15% per week a…uh…run on the fricken bank. Of course, the state has to actually sell investments to generate the cash for all those withdrawals, and seeing as SIVs are getting bailed out by their proprietors (again, as nobody wants them), I suspect Florida is selling some of their assets at tidy losses.

There is a solution, so to speak, to all this…file the puppy:

Should the withdrawals continue, Florida’s pool may have to consider filing for bankruptcy protection, says John Coffee, a securities law professor at Columbia Law School in New York. “A bankruptcy could handle these kinds of problems if they feel they’ll become insolvent,” he said.

Mr. Coffee is spot on – filing will stave off the run, but it also means the funds would be frozen by the court until the matter is resolved. When it comes to financial assets resolution generally means orderly liquidation, or everyone sitting around with their thumbs up their behinds, simultaneously hoping the remaining assets rise in value and paying bankruptcy attorneys virtually every dime of any increase. In addition, any local governments that pulled their money out in the last few weeks might be forced to return it or suffer many preference payment lashings at the hands of the U.S. Bankruptcy Court. I can see them all buying twenty-year supplies of textbooks and container loads of new chalkboards right about now.

Meanwhile, I hadn’t reached the third paragraph of the news when I thought “who’s going to file the lawsuit, the state or the municipalities that don’t get out in time?” Who knows for sure, but the experts are presumptive:

Coffee predicts the pool will likely file lawsuits to recover losses. “I’d expect the pool is going to sue the people who sold them the commercial paper, saying the risks were hidden,” he said.

While the state bears some burden of doing their due diligence, there’s a pretty good chance the risks were hidden too. The finance industry has a nasty habit of overlooking needed disclosure when they’re trying to get the next, best, hot product out the door. I’m going to go out on a limb and suggest this case follows the rule rather than the exception, and even if it doesn’t there’s a pretty high likelihood lawsuits will be flying anyway…this is America we’re talking about after all.

Lehman Brothers Holdings Inc. sold Florida most of its now default-rated asset-backed commercial paper. Lehman spokesman Randall Whitestone declined to comment.

Declining to comment, particularly when said declination comes from a spokesperson (whose sole job it is to comment), can usually be interpreted as “We’re lawyering up, and will call you when counsel has blown through a few retainer checks.”

There are two concepts worth keeping in mind here: 1) Florida isn’t the only government that is having this problem – it’s just the first; and 2) I don’t own any Lehman Brothers Holdings, Inc. common stock.

UPDATE: As of Thursday morning, the State fund has halted withdrawals, but not until after an additional $3 billion was pulled. Executive Director Coleman Stipanovich noted:

“There is no liquidity out there, there are no bids” for those securities.

Translation: the political damage from stemming the withdrawals is less than the losses that would otherwise be incurred from liquidation.

UPDATE 2: Participants in the Florida pool are now…what I’ll call “nicely demanding“…a hundred cents on the dollar for their deposits. You might also call this “wishful thinking.”

UPDATE 3: Having trouble paying teachers.

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