Dec. 4 (Bloomberg) -- Florida's pension fund owns more than $1 billion of the same downgraded and defaulted debt that sparked a run on a state investment pool for local governments and led officials to freeze withdrawals, according to documents obtained by Bloomberg News through an open records request.

The State Board of Administration, manager of $37 billion in short-term assets, including the pool, also oversees the $138 billion Florida Retirement System. The board purchased $3.3 billion of debt whose top ratings were reduced following the collapse of the subprime mortgage market.

Like the hundreds of school districts and towns unable to access $14 billion frozen in the Local Government Investment Pool, Florida's 1.1 million current and retired state workers rely on the board's management to boost returns on the funds that pay their pensions. That has left them vulnerable to the same potential for losses. A state-created home insurer and the treasury are also at risk.

``These were highly inappropriate investments for taxpayers' money,'' said Joseph Mason, a finance professor at Drexel University in Philadelphia. ``This is the tip of the iceberg for pension funds. We know the paper is sitting there. There are substantial subprime-related losses that haven't shown up yet.''

`Unknown Risk'

As officials in the fourth-largest state weighed options for the local government pool last week amid unprecedented withdrawals, Florida Chief Financial Officer Alex Sink rejected a proposal to have the state pension fund assume the risk of its $1.5 billion of downgraded or defaulted debt in exchange for a payment from the pool. She asked ``whether or not it's advisable to put these suspect instruments in the Florida Retirement System.''

``We're talking about transferring really an unknown risk at this point over onto the backs of the millions of retirees that depend on our pension fund to be making wise investments,'' Sink said. She didn't mention that the retirement system already owned these instruments.

Tara Klimek, a spokeswoman for Sink, said the retirement fund has a different objective than the local government pool.

``The objectives of the pension fund are different because it's a long-term fund,'' she said. ``I am not justifying them or saying they are appropriate,'' Klimek said of the downgraded and defaulted holdings.

``Garbage is garbage,'' said Harvey Pitt, former chairman of the Securities and Exchange Commission. ``Once they recognize it's not fit for human consumption, they have to exercise their fiduciary obligation and get rid of it.''

State Treasury

Sink, a trustee of the state board along with Republican Governor Charlie Crist and Attorney General Bill McCollum, is also in charge of the $25 billion state treasury.

As of Sept. 30, it held $592 million in commercial paper sold by a structured investment vehicle, or SIV, of which $180 million was placed under review for a possible downgrade by Moody's Investors Service.

The treasury stopped buying SIVs and asset-backed commercial paper last month. SIVs are typically offshore companies created by banks and other firms to sell low-yielding short-term debt to buy higher-yielding mortgage securities and finance company bonds.

``It's clear we can no longer solely rely on an investment's credit rating when making management decisions,'' Sink said in a statement issued by her office in mid-November.

BlackRock Plan

Sink, Crist and McCollum at a cabinet meeting today approved a plan by BlackRock Inc. to split the local government fund in two, isolating troubled investments, as they sought to reopen the pool for limited pullouts. BlackRock, a New York- based money management firm, was hired by the trustees on Nov. 30, a day after they suspended withdrawals.

The trustees of the state board named BlackRock the interim manager of the fund, taking away state management of that money, while they seek an outside firm to run it. Coleman Stipanovich, executive director of the state board, resigned.

Like the local government pool, the pension fund owns debt of a defaulted SIV called Axon Financial, whose credit rating was cut to D from C by Standard & Poor's last week. The retirement fund holds $250 million of debt sold by the SIV. Florida's pension fund holds $93 million of debt issued by Ottimo Funding, reduced to D from C by S&P on Nov. 9.

KKR Trust

The pension fund owns $420 million of commercial paper from KKR Atlantic Funding Trust, which was slashed to D from B by Fitch Ratings on Oct. 8. It has $297 million issued by KKR Pacific Funding Trust, lowered to D from B by Fitch on Oct. 2. Fitch said the reduction to default on the debt reflected non- payment under the original terms. The debt was restructured to extend the maturities to February and March, and interest payments are continuing.

Citizens Property Insurance Corp., an insurer created by the state to provide hurricane coverage to residents in high- risk areas, has half its $10 billion of assets managed by the state board. That includes more than $3 billion of cash moved from private money managers this year in an effort to save $2 million annually.

``Citizens was not going from a risky position to a conservative position, but from a conservative position to a more conservative position,'' said John Forney, an adviser to Citizens and managing director for public finance at Raymond James Financial Inc., at an Aug. 2 investment committee meeting.

The insurer pays St. Petersburg, Florida-based Raymond James a $10,000 monthly retainer to provide investment policy advice.

Frozen Assets

Citizens has $1.9 billion, or almost 20 percent, of its assets frozen in the local government pool, and $583 million of subprime-tainted debt that was bought by the state board, according to the documents obtained by Bloomberg.

The insurer's chief financial officer, Sharon Binnun, said she had confidence in the state board in an interview Nov. 28, the day before withdrawals were suspended.

Citizens holds $225 million of the defaulted Axon Financial SIV. It has $47 million of defaulted Ottimo Funding, and a combined $289 million of KKR Atlantic Funding and KKR Pacific Funding.

``I believe that the investment Citizens has in the pool is a secure investment and meets our investment guidelines,'' she said.

Citizens, which insures 1.3 million residents, hasn't marked down the value of debt now rated default, Binnun said. ``We do not have any information at this juncture that these are permanent declines in value,'' she said.

To contact the reporter on this story: David Evans in Los Angeles at davidevans@bloomberg.net.

Last Updated: December 4, 2007 14:44 EST