Apples And Oranges?

There's nothing about Nevada's $300 million state investment pool to suggest a repeat of the $2 billion loss in Orange County, Calif.: It uses no leverage and owns very few derivatives. Still, State Treasurer Robert L. Seale, who manages the pool, has spent the past two weeks reassuring the 75 nervous school districts and towns whose assets make up the pool. "My phones have been ringing off the hook," he says.

Get used to it. The Orange County debacle has pushed local government investment pools, or LGIPs, under the microscope. Relatively new, little understood, and subject to a patchwork of state regulation, LGIPs suddenly are being viewed by investors with deep suspicion. There's no shortage of targets for concern: Hundreds of pools may be in existence--no one is really certain--and some $80 billion is invested in state pools alone, according to Fidelity Investments.

The strategy driving LGIPs is simple enough: By pooling funds to gain clout with Wall Street, LGIPs often provide small municipalities with higher returns than they could reap themselves. The problem: The pools operate in a backwater of municipal finance. Many don't price assets daily, making it tough to assess their worth. And they have no uniform disclosure requirements or federal oversight. Rating agencies are scrambling to analyze the pools, which until now have been viewed as benign cash-management vehicles. "The investment pools have existed in a quasi-never-never land with far less oversight in some cases than is necessary," says Robert B. Lamb, finance professor at New York University.

PURE PANIC. Now, investors are starting to get nervous. One of the casualties is TexPool, a state LGIP run by Texas Treasurer Martha Whitehead. TexPool used no leverage and had only 2% of its assets in derivatives, which it since has sold. Comparisons to Orange County are "absolutely incorrect," says Texas assistant deputy treasurer John A. Bell.

Still, dramatically higher interest rates have caused $70 million in paper losses on the Treasury securities in TexPool's portfolio. News of Orange County's disaster brought withdrawals by 100 of TexPool's 1,300 investors, causing the fund's assets to drop from $3.8 billion to $2.3 billion on Dec. 13. Jim Keyes, director of fiscal services for Fort Worth, says he withdrew $5 million. "We have no concerns about TexPool being solvent or being managed properly, but there's such a panic we decided to withdraw."

There could be more problems lurking. Other California counties, among them Los Angeles, operate LGIPs. These pools, like Orange County's, are subject to lenient California rules that allow more leverage than any other state. NYU's Lamb anticipates further losses in California--and, indeed, in municipalities nationwide.

That could prove the very dear price of allowing a public investment entity without enough disclosure, regulation, and market discipline.