Now these cash managers’ operating portfolios are bleeding yet more red ink as the market value of their portfolios has sunk even deeper. They are still locked in to large chunks of underperforming longer-term paper that they foolishly bought in the past year to chase minuscule yield pickups, forfeiting the benefits of higher short-term market interest earnings as those rates ratcheted upward. The latest inflation readout wiped out any remaining delusions that rates would recede soon and make them whole again.
What’s been happening in California tells a tale that’s being replicated in too many places across the country. Most of the Golden State’s elected treasurers who were spotlighted in my May column ignored my warnings. More than a few of them stuck to their 300-day-or-longer average portfolio maturities, and several actually increased their average maturities and pyramided their market risks as their red ink surged. Even in June, when there was a brief respite in the markets to give them the opportunity to stress test their portfolios and shorten their over-extended maturities to reduce market risk, they kept wearing their blinders and foolishly plodding ahead in their nonsensical long-maturity graveyard where the public’s cash has now gone to die.
In the case of the California state treasurer’s local agency investment fund, the latest published yields are still well below 2 percent. By contrast, the institutional money market’s overnight interest rate now exceeds 3 percent and is on its way to 4 or higher, with super-safe Treasury bills abundant in that range. These supposed fiduciaries are underperforming mainstream money market yields by a factor of roughly 50 percent, squandering $3.5 billion of portfolio value so far this year.
In my prior professional life, when I was president of two national mutual fund complexes, we canned money managers for less. Why California’s local agencies have kept their money in that fund instead of investing elsewhere continues to baffle me.
And it’s not just the state’s fund. There are multiple counties and municipalities in California and elsewhere with a similar sob story. Los Angeles County, with its inexplicable, consciously elongated 1,000-day average portfolio maturities, is rapidly catching up to the state in their perverse race to the bottom. Apparently the county supervisors, CEO and internal auditors there don’t bother to read investment reports. Amazingly, these treasurers and several prominent outsourced cash managers have been able to sweep it all under the rug, avoiding justifiable public outcry. Mysteriously, nobody else is calling them on the carpet, even with elections coming up next month.
Unprecedented Losses
The September monthly investment reports, soon to be released, will reveal yet more deep-red ink in market values — the worst ever on a cumulative basis. There is no record of a worse performance history in U.S. public cash management, even during the notorious era of Fed Chairman Paul Volcker’s tight-money regime, when rates went higher overall. These market losses collectively now dwarf the Orange County, Calif., portfolio losses that led to bankruptcy there in 1994, even after accounting for inflation.
This saga would be incomplete without mentioning that the Orange County treasurer’s office actually cut its losses in recent months. Apparently awakening to the powder keg on which they were sitting, its cash managers stopped buying longer maturities and allowed the portfolio average to decline by a factor of more than 24 percent through Aug. 31.
That runoff saved megamillions of taxpayer funds, so the incumbent there, Shari Freidenrich, deserves credit where credit is due. But Orange County's recent risk mitigation was far and away the exception. Other jurisdictions' persistent investment blunders have been unparalleled and historic. The lost interest income that these treasurers have squandered away won’t be available to pay bills this year — or ever.
Someday, probably next summer or beyond, their robotic insistence on longer maturities may eventually bear some shriveled fruit, as the Fed succeeds in slowing the economy down to a standstill (or worse, as some fear) and the CPI eventually starts to trend below the overnight interest rate. Clearly, a business slowdown is already underway. But even if it plays out that core inflation recedes and remains below 4 percent next year, that won’t bring these 2022 losses back to life. The billions of easily attainable interest-income dollars that have now been dissipated this year cannot be recovered by a riskless 2023 bond rally. That river of red ink is now irretrievably over the dam.
A Teachable Moment
There is no point in beating these hobbled horses to death, as those pathetic nags are all now well out of their barns. But their jockeys’ numbed thick skins should not relieve these governmental treasury managers, internal auditors and their associations of their prudential responsibility to scrutinize 2022 as a teachable moment for their policy and education committees.
All their groupthink lip service about “cashflow stress tests” clearly needs to be buttressed with elementary market scenario risk disclosures and break-even-yield tests that would take into account the now-obvious market forces that these officials so foolishly ignored this summer. Beyond the hubris of it all, there are clear deficiencies of accountability and stakeholder oversight. This case history screams out for candid after-action analysis.
We still have seven more years to go in this tumultuous decade, but for now this collective failure ranks No. 1 as its top public finance fiasco.
When the day ultimately comes that longer maturities could make sense, I hope to return with strategies to work that angle, but right now it’s time for public treasurers and portfolio managers who are foundering in deep pools of red ink to look in a mirror for its source.
Governing's opinion columns reflect the views of their authors and not necessarily those of Governing's editors or management. Nothing herein should be considered investment advice.
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