Treasurer: Don’t Buy Junk Bonds for State Pension Fund

State Treasurer Thomas W. Hayes, breaking sharply with the majority of directors of the California Public Employees’ Retirement System, said Monday that the $56-billion pension fund should stop buying junk bonds.

“Let’s stop purchasing these types of investments,” Hayes said during an unusual public airing of differences with DeWitt F. Bowman, chief investment officer of the pension fund, at a news conference in the treasurer’s Capitol office.

During the news conference, Bowman revealed that in addition to making an unsecured loan of $25 million to the now-bankrupt investment firm of Drexel Burnham Lambert Inc., the pension fund has $87 million in paper losses stemming from the collapse of the junk bond market.

Bowman said that as of March 1, the value of his pension fund’s $529.3 million worth of “high-yield” bonds had dropped to $442.7 million.

The investment chief said PERS had stopped buying junk bonds temporarily because the bond market is “completely unsettled and embroiled in the Drexel situation.”

But he said he and other PERS officials still believe that the high yields associated with the bonds make them a risk worth taking. “The maximum return for the system over the long term can be gathered by diversifying the investments, taking some risk when it’s appropriate,” he said.

Hayes--seated next to Bowman at the news conference--said, “My recommendation is: Don’t buy any more.”

In February, Hayes attempted to persuade other members of the 13-member PERS board of directors to temporarily halt the purchase of junk bonds pending a review. The vote on his proposed moratorium was 7 to 6. He said he will try again at the PERS meeting later this month.

His comments Monday went further than previous statements and seemed to reflect the heat of the primary election campaign. Hayes, appointed treasurer by Gov. George Deukmejian last year, is running for his first full four-year term this year.

Hayes has been under fire from his opponent in the Republican primary election, Angela M. (Bay) Buchanan, for accepting more than $4,000 in campaign contributions from Drexel and its officers.

Buchanan, in Sacramento for campaign appearances, said later that Hayes “should give a complete explanation” of the unsecured Drexel loan and should refuse to accept any more contributions from investment banking firms.

“In a situation like this, people are going to be concerned that he wasn’t as tough as he should have been,” said Buchanan. “When he’s taking money from them, when they are helping to finance his campaign, one wonders if there is a quid pro quo here.” She said she knew that the $25-million loan from the retirement fund to Drexel was made in 1986, long before Hayes became treasurer. But she said that as treasurer, Hayes should have seen the Drexel debacle coming and taken steps to protect the PERS investment.

Hayes said the state has absolutely no control over the loan, a 10-year note earning a 10% rate of interest. “It was a private placement. Once you buy it, you are basically stuck with it till the end,” Hayes said.

Hayes and Bowman both said they hope PERS will recover most if not all of the money owed to it. Hayes said the loan to Drexel was “a business decision” that “was not inconsistent with what their policy was at the time, nor what the policy is at this time.”

Also at the news conference with Hayes and Bowman was Thomas E. Flanigan, chief investment officer of the State Teachers Retirement System. He said his pension fund, which controls $29.6 billion in investments for retired teachers, decided in 1985 not to purchase junk bonds. Basically, Flanigan said junk bonds carried just too much risk. Hayes also said that there are no junk bonds in the $21-billion investment portfolio that he controls as treasurer.