The state treasury has gotten itself out of a $1 billion investment pickle.
The Department of Budget and Finance has arranged to cash out its remaining position in a huge investment that was hard to exit and attracted withering criticism from the state auditor three years ago.
Hawaii treasury officials invested $1 billion five or so years ago in something called student loan auction rate securities, a type of investment that had become popular with institutional money managers because of attractive returns and the ability to cash out quickly.
But when the market for these securities froze in 2008, the state confronted the prospect of leaving its investment tied up or selling at a dramatic loss.
The auction rate securities the state bought were a form of bonds backed by student loans. Though complicated, the securities once enticed investors with higher returns than savings accounts or certificates of deposits and the flexibility for quick and easy conversion to cash.
Investors could move in and out of the securities every seven to 35 days through auctions, and big investment firms marketing the securities pledged to repurchase the bonds themselves if no buyers bid at auction.
State treasury officials shifted large amounts of investment money into such bonds even as the auction rate market started to tighten in the second half of 2007.
But when the market froze, broker buyback guarantees vanished, and $1 billion in state treasury money became trapped along with an estimated $330 billion in the market.
As the problem came into focus, Bloomberg News reported that one Citigroup broker sold Hawaii half its auction rate securities in the eight months before the market collapsed, as the banking firm was trying to dispose of these bonds.
The investments also became the subject of a 2010 audit by state Auditor Marion Higa that said Budget and Finance officials under Gov. Linda Lingle lacked leadership and accountability and did not effectively manage state revenue.
The audit said the investments didn’t comply with state laws and policies requiring that short-term investments maintain a AAA rating and mature in less than five years.
The audit also said loading the state’s investment portfolio with more than 20 percent of such securities violated diversity guidelines.
Lingle’s Finance Director Georgina Kawamura defended the bond purchases as a prudent investment that was permitted by law but took an unforeseen turn.
Lingle harshly criticized Higa’s report at the time as shoddy, unprofessional and politically motivated.
She also called on state lawmakers to investigate Higa.
Higa responded by challenging Lingle and her administration to a lie detector test.
Meanwhile, the state was hamstrung in the midst of a budget deficit and a recession. Kawamura said trying to liquidate the investment immediately would probably result in a $200 million loss.
Legislators were told the state was prepared to hold the investments until they matured and that an average return of 1.85 percent was higher than short-term investment options.
But state officials did work to sell the bonds ahead of maturity, and reached a settlement with Citigroup in November 2010 in which the company agreed to purchase what had been trimmed down to $869 million in auction rate securities by June 2015.
On Monday, Gov. Neil Abercrombie announced that Citigroup has bought $638 million of the state’s troubled investment and has agreed to buy the remaining $231 million.
Abercrombie said the accelerated sales result in no loss to the state.
State Finance Director Kalbert Young said money from the sale will be strategically reinvested.
“While this does not result in any additional new money to the state, it does allow us to strategically invest these funds to meet future obligations,” he said in a statement.
Frank Chin, managing director of Citigroup’s public finance department, said in a statement that the company is pleased to have worked closely with the Abercrombie administration to remove all the auction rate securities from the state’s portfolio well ahead of the agreement schedule.
“We are proud of our longstanding relationship with, and commitment to, the state and are pleased to see this issue resolved,” he said.
