Ventura Comes After Vallejo? Some Thoughts on Municipal Finance in California

On March 19th however, the City of Ventura jolted Ventura citizens to life with the announcement that cuts would likely need to be made and quickly. The list of probable cuts is extensive, including closing City Hall every other Friday and an immediate hiring freeze. At least I thought, the City has finally caught on to the economic downturn by stating, “Locally, the economic downturn has affected City revenue through a loss of expected sales tax dollars - currently 10% below projections; decreased property tax from falling home prices - down 24 percent over the prior year; and a decrease in revenue from building permits - down more than 15 percent from expected totals.”

Then part of the next sentence in the press release jumped out at me, “liquidity has also been affected; the City holds $10 million in what were AAA rated Bear Stearns investment notes”. $10 million of the City’s assets were “invested” in Bear Stearns private assets which had been technically reduced to almost worthless in the JP Morgan buyout of near-bankrupt Bear Stearns. What the City means is that their ‘investment’ is illiquid because it cannot be exchanged on the market for any amount of money close to the initial investment. That is to say, it is near worthless as long as it has no liquidity value.

Stepping back, we need to see there is a very special role that needs to be played with City assets by their Finance Officer and Finance Office. Paramount in any city finance mission is preserving the safety of the reserves and minimizing risk. If you review charters from municipalities all over the country, you will see that preserving financial assets is supposed to be their top priority; any investment for gain should be done with the primary goal of asset preservation in mind.

City finance officers are supposed to be trained in public finance and have competence to determine the financial safety and viability of any investment proposal. Most cities invest their cash assets in highly safe Treasury instruments and other government-backed securities. Risking money with an investment bank such as Bear Stearns would not be high on a list of prudent investments. Pure investment banks such as Bear Stearns are not remotely similar to commercial banks such as Wells Fargo or Bank of America. There is no form of government insurance for deposits, and they are recognized as focused on higher risk ventures such as hedge funds, etc. Bear Stearns was also heavily exposed to subprime mortgages, plus the firm had less capital and was less diversified than even its investment bank rivals.

Moreover it should have been no big surprise to anyone paying attention that Bear Stearns was in trouble. As early as nine months ago, evidence of their trauma was in the news. (See Box – Bear Sterns, The Evidence of a High Risk Gone Bad) It can never be said that Bear Stearns’ problems were flying below the radar.

BOX
Back on June 22, 2007 as reported by the New York Times and popular press, Bear Stearns pledged a collateralized loan of up to $3.2 billion to "bail out" one of its funds, the Bear Stearns High-Grade Structured Credit Fund, while negotiating with other banks to loan money against collateral to another fund, the Bear Stearns High-Grade Structured Credit Enhanced Leveraged Fund The funds were invested in thinly traded collateralized debt obligations (CDO) found to be worth less than their mark-to-model value. Merrill Lynch seized $850 million worth of the underlying collateral but only was able to auction $100 million of them. The incident sparked concern of contagion as Bear Stearns may be forced to liquidate its CDOs, prompting a mark-down of similar assets in other portfolios.

During the week of July 16, 2007, Bear Stearns publicly disclosed that the two subprime hedge funds had lost nearly all of their value amid a rapid decline in the market for subprime mortgages. END BOX

Given the ample and public information regarding the woes of Bear Stearns, last July the financial stewards at the City of Ventura should have been taking actions that would have put Ventura at less risk. There is no good reason I can think of why Ventura is still holding Bear Stearns bonds which are presently worthless and which could have been sold on the market months earlier when Bear Stearns was clearly in so much financial trouble.

So we have two questions for the people charged with protecting our financial assets at the City of Ventura.

--Why did you even think about investing money in high risk investment bank debt obligations?

-- And, once it was clear there was a big problem with Bear Stearns, why did you not take action to avert the potential for a disastrous loss of needed reserve funds?

The stated investment policy for Ventura identifies “safety” of principal as the foremost objective of the City investment program. And yet with evidence mounting in the investment world for the past year that risk was high and ever increasing, the stewards of our financial assets did not act to lessen risk and the elected officials to whom they report did not intervene.

How Did This Happen?

The City is supposed to have an oversight and advisory committee which is to help guide the City in investment matters. But when we look at the membership of this group called the “Investment Oversight Committee” in Ventura we find it is comprised not of outside, independent financial advisors who could provide real advice, expertise and oversight. Rather it is composed of City Manager Rick Cole and three of his finance department employees and only one non-employee member, Rosa Lee Measures. Checking the public record shows that Ms. Measures in addition to performing on the Ventura City Council in past years has made a career in banking over 25 years, serving as Vice President and Regional Manager of the Imperial Savings and Loan Association.

Call me naïve but where was the representation of someone who is steeped in the financial practices of modern day public investment? Where is the evidence that anyone familiar with the daily topsy turvy atmosphere of fixed income investment was even available for consultation? In other words and with all due respect for Ventura’s pride in self-management, who was watching the store? How could anyone having any sense of the investment world not realize until sometime in March 2008 that major financial institutions all over the globe were crumpling like a cheap suit?

I keep wondering—am I asking too much? What do other cities do? What does their advisory body look like?
I would say that either the people responsible for money management in the City of Ventura didn’t know what was happening or that they knew what was happening and chose to ignore the consequences. In any event, Ventura citizens deserve better and should demand better from their public servants and those who choose to lead them in elected office. Let’s also hope that other cities have not gone down the treacherous financial path taken by the City of Ventura.

Frank Pecarich lives in Ventura County and has followed California politics and public policy for over 40 years.