UPDATED: Pennsylvania has so much stock and bonds in state accounts that, over the past 10 years, it's been able to loan securities worth billions to hedge funds, short-sellers, and other international speculators, collecting fees that averaged $50 million a year, according to data from state Treasurer Rob McCord's office.
The state would take cash in exchange for the borrowed stock, and invest it in money-market funds and other secure investments. Profit turned to loss last September, when one of the investors (not borrowers), Sigma Finance Corp., a unit of London-based Gordian Knot Ltd. that used to invest in U.S. home loan mortgages and other risky assets, said it couldn't repay $133 million to Pennsylvania, after the value of its investments collapsed and its credit ratings were cut by Standard & Poor's and Moody's in a series of moves that began the previous Spring.
After September, then-Pennsylvania State Treasurer Robin Wiessmann stopped the securities lending program for a "re-evaluation," said John Lisko, McCord's chief of staff. Bank of New York Mellon has since refunded its $13 million annual fee for last year, Lisko told me. The bank collected $65 million for running the program in 1999-2007.
Other Sigma investors, like Swiss bank Zurich Financial Services AG and the central bank of Colombia, declared big losses when Sigma blew up last year. By contrast, Pennsylvania treasury officials at first hoped to keep the loss quiet and off the books, in hopes at least some of it could be reversed.
But the $133 million now looks like it's gone for good, McCord told Gov. Rendell and ten General Assembly leaders in a letter last week. He detailed the resulting losses:
- $57 million from the Public School Employees' Retirement System;
- $20 million from the State Employees' Retirement System;
- $9 million from the State Workers' Insurance Fund;
- $3.5 million EACH for the Tuition Account Program and the Tobacco Settlement Fund;
- $2.2 million to the Workers' Compensation Security Fund;
- And a total of $25 million to two funds that pool assets for various state agencies -- which will force cuts in payments some agencies were counting on, in the middle of a budget crisis.
Senate Democratic leader Robert J. Mellow, who represents Scranton, is angry about the late disclosure, which he made public yesterday. Despite her background as an investment banker, Wiessmann "didn't know what the hell was going on here," Mellow told me. "Why didn't she bring this to our attention?" The treasurer spent too much time doing "public service announcements" and hosting visits by former Vice President Al Gore, instead of responding to "red flags" that showed state investment values were collapsing, Mellow said.
UPDATE: Wiessmann says her office was on top of the unusual situation and worked hard to limit losses. When she left office in January, negotiations were ongoing to get the money back. Other states had similar problems with securities lending; and Pennsylvania lost billions more in the investment market collapse than from security lending.//
"I've been in the Senate since 1970, and this is the worst budget cycle we've ever had," Mellow added. "To lose $135 million in taxpayer money this way is inconceivable." He's asked state officials to weigh possible lawsuits against Sigma, Gordian, and Bank of New York. He'll meet with McCord to learn more Monday.
There's obvious questions for the bank: Why was Sigma, which focused on high-yield bonds, considered an appropriate investor for short-term loans? Why didn't managers pull Pennsylvania's funds as soon as S&P and Moody's started downgrading Sigma in early 2008 [corrected], instead of waiting until it was too late? Why did the bank give back its fee? And who, if anyone, should make taxpayers whole? Bank spokesman Ron Gruendl says he'll have answers "soon". UPDATE: Gruendl says the bank worked hard to limit losses, etc. More in tomorrow's Inquirer.