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Monday, December 03, 2007 10:01 AM

Sell Now Ask Questions Later

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Concern over asset backed commercial paper is still growing. The State of Florida has frozen assets in the Florida School Fund as noted in Freeze Is On In Florida. Now Maine Treasurer Lemoine Criticizes Merrill for Subprime Bet.

"I have deep concerns about the recommendations and the process by which that (paper) was delivered to us," Maine state Treasurer David Lemoine told Reuters in an interview. "What was in the background at Merrill Lynch for funneling that [Mainsail II] suggestion through their broker to us for purchase?"

Mainsail II assets were frozen in late August.

While Maine has not lost any money on the Mainsail II investment yet, Lemoine said it will take weeks if not months for the investment to be unwound carefully.

"If there is no harm, there is no foul. We need to see how it unfolds eventually in terms of the payment process," Lemoine said, declining to say how he might move against the New York investment bank and its brokers.

"As a practical matter, we are not using commercial paper anymore and so we are not dealing with any brokers, including Merrill Lynch," Lemoine said. Instead, some of Maine's short-term cash is now being invested in fully collateralized bank deposits, which earn the state less money, but are deemed very safe.
Odds the there being no losses in are Mainsail II zero. And speaking of zeroes, the odds are overwhelming that the current investment value of Mainsail II is closer to zero than to 50% of the original investment regardless of how "carefully" unwound the investment is.

As a practical matter asset backed commercial paper is dead and is not coming back. The flight to the safety of cash is on.

Run on Montana Fund

Following in the footsteps of Florida, a Run on a Montana Fund is now in progress.
Montana school districts, cities and counties withdrew $247 million from the state’s $2.4 billion investment fund over the past three days after officials said the rating on one of the pool’s holdings was lowered to default. The fund, managed by the Montana Board of Investments, holds $90 million in Axon Financial, a structured investment vehicle, or SIV, that was cut to “D” by Standard & Poor’s amid the collapse of the subprime mortgage market.
Seattle Based King County Pool Is Exposed To Mainsail II

SIV Debts have been a Disaster For Public School Funds.
King County finance director Ken Guy says he thought the fund was making a safe investment when it bought $53.5 million in commercial paper of an SIV-lite called Mainsail II in July. Mainsail failed to make payments to investors, including King County, on Oct. 4.
Sell Now Avoid The Freeze

Canada is still coming to grips with its frozen, now partially unfrozen ABCP mess as detailed in Global Credit Crisis Canadian Style, Minyan Mailbag: Money Frozen In Yukon, and Commercial Paper In The Unfrozen North.

It's too late for some districts in Florida as emergency funding is needed to pay teachers.
Schools in America are being forced to seek emergency loans to pay teachers after a multi-billion dollar state-run investment fund was forced to freeze withdrawals as the credit crisis takes hold.

Jefferson County school district was one of at least six school districts in Florida forced to take out last-minute loans to pay teachers after their requests for withdrawals were refused.With the size of the fund reduced to $14bn and continuing uncertainty about the level of sub-prime mortgages the fund was exposed to, its manager, the Florida State Board of Administration, was forced to close the books.

"If we hadn't done something quickly we would not have had a fund at all," said Coleman Stipanovich director of the Florida State Board of Administration.The State Board is considering ways of shoring up the fund including tapping into its $137bn public sector pension fund. Unsurprisingly the idea has met with stiff opposition from union officials representing public sector workers.

Managers of the Florida scheme, the largest of its type in the country, are to hold an emergency meeting on Tuesday to discuss how they can put in place a system to allow emergency withdrawals.
Marked To Reality

Why yes, this is yet another Zugzwang.

Florida officials want to freeze the fund but they need to pay the bills. Paying the bills means marking to reality any assets that are sold.

For more on the concept of what marked to reality means, please see E*Trade Marked To Reality - What Happens If Citigroup Is?

What I expect Florida to do is sell off assets worth full value or nearly full value leaving increasing concentrated toxic waste left in the fund over time. Perhaps in an effort to decrease toxicity, local taxes will be raised or new sin taxes implemented. Either way, someone has to pay for this mess. All freezing the fund accomplishes is a delay of one problem while creating new ones such as inability to pay teachers.

Looking ahead I expect to see a run on and/or a freeze in the Seattle-based King County Investment Pool fund. Who wants their assets to be frozen? Certainly those that get out first will be in the best shape as the situation in Florida proves.

The problem goes beyond school funds to the very heart of where many store money. While not a money market but rather a short term institutional bond fund, GE's "enhanced" cash fund willingness to break the buck may have been a key event.

I am wondering how much longer the likes of Legg Mason (LM), Wachovia (WB), and Credit Suisse (CS) are going to be willing to support their money market funds.

By the way, who wants to find out? This is what Hal Wilson, CFO for Jefferson County Florida had to say about his decision not to withdraw based on assurances from the state board that the money would be secure:
"I might not be able to pay our employees tomorrow," he said, referring to his $850,000 payroll. "I am sure that those money managers who withdrew all their funds are feeling really smug right now, thinking they did the right thing. But it left the rest of us holding the bag."
When it comes to Asset Backed Commercial Paper problems Sell Now, Ask Questions Later sure seems like a reasonable strategy.

Mike "Mish" Shedlock
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