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The Bubble

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By Alec Klein and Zachary A. Goldfarb
The Washington Post
Tuesday, June 17, 2008

Jackie Pons, the affable superintendent of the Leon County school district in Tallahassee, was worried about his $30 million.

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One Wednesday last November, he got on a conference call with Florida officials and financial advisers representing cities, towns and school boards throughout the state. The officials hoped to calm nerves. Localities had started to pull huge sums of money -- billions of dollars -- out of their accounts in a state-run investment pool, panicking that the fund was vulnerable to the financial alarm sweeping the nation over the collapse of the housing market.

After years of giving out mortgages to millions of people with less-than-stellar credit histories, lenders were imploding as subprime borrowers defaulted on their loans. The contagion spread quickly to Wall Street, which had packaged those risky loans and sold the securities to big investors in the United States and around the world.

Investors, in turn, wondered whether the problems in the financial system would extend beyond subprime-backed securities to investments backed by conventional mortgages -- or even other assets.

In Florida, the crisis was about to filter down to the lives of people who had no obvious connection to the financial world. Officials in charge of the state-run investment pool had for months maintained that the money was safe. "I want you to know I have no serious concerns at this time about any of our exposures," the then-head of the fund wrote in an e-mail to the office of Florida's chief financial officer.

But now state officials were trying to stave off a run on the fund by officials like Pons. His district was considering withdrawing the approximately $30 million it kept in the pool, which served as a kind of money-market account for localities to cover their payrolls and other operating costs. On the conference call, state officials assured the gathering that the fund had lost only a fraction in value and that everything was fine. "I believed them," Pons said. "I took them for their word."

The next day, Thursday, state officials abruptly shut down the pool to put an end to the run. About 1,000 localities couldn't withdraw their money.

Pons wondered where he would find $10 million overnight to meet the next day's monthly payroll. "I'm sitting there going, 'Whoa.' We're sitting here with no access to dollars," he said.

The superintendent was acutely aware that many of his employees lived paycheck to paycheck. "This is like, no, this is America, these are our dollars, they can't stop us, we're going to miss a payroll," he said. "This is what you read about in other countries."

The pool, after all, was supposed to be safe, investing public money in such boring instruments as Treasury bills. But as interest rates fell in recent years, the pool began moving toward higher-yielding, complex investments such as short-term corporate debt.

"The pool was certainly trying to get reasonable returns within the boundaries of being a money-market fund," said Robert Milligan, a retired Marine lieutenant general who is interim executive director of the board overseeing Florida-run funds. Milligan said the pool invested only in securities with high grades from credit-rating companies.

Only a small percentage was invested in mortgage-backed securities, and an even tinier amount -- 0.03 percent -- was in subprimes. But Florida was swept up in the national frenzy as some of its mortgage-backed investments were downgraded by the credit raters.

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