AUTUMN ZAMZOW and PEGGY ECKROTH, Partners, Autumn Capital Investment Services
Government Treasury securities look so safe. But investors of public money learned that looks can deceive, thanks to Newport Beach financial consultant Steven D. Wymer. He is accused of defrauding a dozen small cities--including Orange--out of at least $113 million. Autumn Zamzow and Peggy Eckroth are co-owners of a Dana Point firm that advises municipalities on investments, and Eckroth is a board member of the Local Agency Investment Fund, a state investment pool. They spoke with free-lance writer Anne Michaud.
There is concern that public money was lost recently through investments with firms operated by Steven Wymer. Aren’t there guidelines as to how public money can be invested?
ECKROTH: Cities’ investment policies are normally based on California Government Code 63-601. It spells out specifically what a city can invest in, the types of investments, etc. It even talks about using money-market mutual funds or outside money managers. There are some pretty stringent guidelines.
Both investments met the guidelines, but they turned out to be unsafe. How do investors protect themselves?
ZAMZOW: There are two kinds of (fund) pools available right now--regulated and unregulated (by the Securities and Exchange Commission). Regulated funds watch out for your money if you don’t have the expertise to know whether you’re getting a fraudulent statement. Most treasurerswould not know how to ascertain that that was happening. I don’t think I would. A lot of the pooled funds buying treasuries are not regulated by the SEC.
With the Executive Life situation (in which pensionfunds were endangered by the company’s risky junk- bond investments), if you’re getting a yield so muchhigher than the rest of the world and you have a fiduciary responsibility, you should be asking why. That’s the law of the land: High yield means higherrisk. There’s just no magic in the investment arena,unless you’re buying a riskier security, and Executive Life was doing exactly that in the junk-bond market. (The higher yield) should have been a red flag, and it was to numerous issuers of bonds.
Are there many investment pools available to municipalities?
ZAMZOW: Colorado has a number of them. There are a couple in California that we’re aware of. That’s not to say that they’re not clean. The question is, who knows?
Why would a pooled fund choose to be non-regulated?
ZAMZOW: The reason (money managers) put the pools together in the first place was so they could get out of registering with the SEC and having to be rated. It’s a gap in the law.
If you’re a non-regulated fund, you’re not doing anything illegal. However, in a regulated fund, the investor’s par value is protected; if they invest a dollar, they’ll get a dollar back. They have to have a reserve set aside. And investors make the yields they’re expecting. That’s not a given, even in a money-market mutual fund.
Are municipal treasurers under too much pressure?
ECKROTH: Yes. Right now, all the cities are faced with declining interest rates. Plus, they have budget cutbacks because they have less tax and sales revenues. So they’ve got a smaller amount of money and expanding demand (by city departments), and they’re earning less on their portfolios than they were last year. It’s a terrible position for them to be in. It makes them more vulnerable, and it’s going to continue that way at least for a little while.
We all got very comfortable in the late 1980s with interest rates of between 8% and 10%. Now, all of a sudden, we’re looking at interest rates of 4.5% to 5%.
So, the promise of above-average yields is very attractive?
ECKROTH: Yes, but the majority of treasurers and finance directors understand that there are higher risks with a higher yield, and they’re not willing to take those risks.
ZAMZOW: You have to understand that a lot of these people don’t see large amounts of money daily. Maybe once or twice in their careers do they invest large bond proceeds.
Are those pressures easing now because of the recent lessons?
ZAMZOW: I’m seeing now a lot of backlash that may create more insanity than it’s worth. I think the important thing is that the treasurer is no longer pressured to produce that 8% yield. The treasurers are in the same box right now. Yields are 4% or 5%, but the budget says you’re supposed to be earning 8%, and you’ve made those pension fund assumptions and those actuarial assumptions. There’s a lot of pressure.
Have there been any changes aimed at preventing future losses?
ECKROTH: One thing that is now in place--and this might have protected investors in Executive Life--is a clause that allows investors to withdraw (their money) without penalty if the company’s credit rating is downgraded. As we establish a contract for money to go into a financial institution, there are parameters that specify the existing grading the institution must maintain. If there is a change in rating by Moody’s or Standard & Poor’s, there is an out clause. It isn’t a law; it’s general practice.
ZAMZOW: The credit quality of Executive Life deteriorated, but the contract was ironclad, so the company was not required to give the money back to the municipalities. With hindsight, it would be unusual now to even consider a contract that doesn’t have downgrade language.
Q: Are there more changes coming for unregulated investor pools such as Wymer’s?
ECKROTH: There will be. There is a great deal of concern on the part of all municipal treasurers about protecting themselves from fraud like this.
The immediate tendency is to go ultraconservative and say, we’re only going to buy treasuries and we’re going to buy them directly . . . The problem there is it puts the full responsibility back on the treasurers.
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On being smarter. . . .
“In a conservative market environment, the people who are smarter than everybody else are paying you 6.6% instead of 6.5%. When somebody promises you 7.5%, there’s something going on that’s beyond smart.”--Zamzow
On the potential for future problems. . . .
“Right now, interest rates are going down, but as they start to go back up, people will begin to take their money out of investment pools to earn higher yields elsewhere. That will mean trouble for pools that have invested (in long-term securities).”
--Eckroth
On municipal finance. . . .
“Major corporations end up losing more money than municipal government does, but it’s not everybody’s money. (Municipal treasurers are) in the position where if they lose a dime, the whole world knows it.”--Zamzow
