-A trillion dollars per year of investment activity that’s largely unnecessary, billions left unused and a Treasurer unilaterally using the resulting power for political benefit and policy goals unrelated to his office-
By: Mark Glennon*
Every month, year after year, $11.5 to $14 billion of state money sits nearly idle, invested mostly short term and earning little. That’s a senseless waste, which is a story in itself, but more concerning is growing misuse of the Treasurer’s market power for purposes far beyond his mission and competency. With over $1 trillion per year of investment activity, abuse of the Treasurer’s power is proving too tempting.
It’s called the State Investment Portfolio and it’s not cyclical or temporary. It’s aside from other monies administered by the Treasurer, including the college savings program and funds owned by municipalities invested on their behalf.
As of the date of the last monthly report – September 30 —the portfolio was $13.2 billion. It has stayed between $11.5 billion and $14 billion every month for as long as I found records — at least since January 2014.
What’s the sense in holding that much in near cash when the state is paying 9% to 12% late payment interest on billions in unpaid bills? It’s earning less than 1.3% annualized because it’s invested very short term – the weighted average maturity is less than a year. I first wrote about this last Spring and have still found nobody with anything close to an explanation for it.
The historical explanation for this arrangement isn’t a convincing rationale. Over past decades the state created over 750 separate “funds,” each for restricted expenditures, and the portfolio is money in those funds. There’s a Thoroughbred Breeders’ Fund, a Master Masons Fund and a “Sorry Works!” Fund, though most are more serious. A list is linked here.
Some of those funds must indeed be restricted, such as federal grants, bond escrows and highway money. But a December 2015 Associated Press analysis found that 531 funds holding at least $4 billon could be repurposed by statute.
The current Treasurer, Michael Frerichs, isn’t to blame for how these circumstances arose. The funds were created by statute and the huge balances preceded his tenure.
I asked his office last Spring what sense it all makes. “The simple answer to your question,” they answered, is that “the investment portfolio balance is unusually high because the state does not have a budget.”
But that just wasn’t true. The large balances were there long before the recent budget impasse and have survived it. Since then I’ve asked many others in and out of government why this makes any sense and none has an answer.
The balance in many of those funds, seen individually, no doubt fluctuates heavily, which might seem to explain why the money should be invested short term at low rates. But that makes no sense for why the money as a whole should be managed that way. With $11 billion-plus balances carried month after month indefinitely, the state should be able to do better than 1.3% return.
Another consequence of investing so much money short term is the extraordinary churn that’s required. A CNBC host seemed surprised last October when Frerichs said his office had $30 billion of annual investment activity just with Wells Fargo Bank. Total investment activity, he said, exceeds $1 trillion per year, a staggering number (though that may include investment in activity the Treasurer also handles for separate municipal funds of about $4 to 6 billion and some other smaller accounts). Is that, and whatever cost it entails, really necessary?
Misuse — both potential and actual
• First, Frerichs thinks he can use his investment clout to solve the problem of fake news. He is using an investment in Facebook to try to force it to own up to its alleged role in the Trump/Russia/fake news mess. “I was aware there was fake news but I didn’t realize that many Americans were consuming news that way,” he told reporter Shia Kappos. This is unquestionably far beyond the Treasurer’s job description and politically motivated.
Exactly where and how much Facebook stock the Treasurer holds raises another issue. It’s probably not in the State Investment Portfolio because that’s mostly short term debt. Maybe its in the other $4 to $6 billion he manages for Illinois municipalities or the $8 billion of 529 College Savings Plan money he administers. I don’t know because that information isn’t readily available. All his holdings should be posted. In any event, whatever fund it is that holds Facebook stock isn’t there to solve the fake news problem.
• Second, consider the Wells Fargo scandal discussed in that CNBC video clip. The bank’s conduct was unquestionably outrageous. They’ve admitted opening about 3.5 million fake accounts. Treasurer Frerichs responded by cutting them off as broker-dealer for about $30 billion of state investment funds annually, which he said will cost the the bank “millions” of dollars in fees.
Maybe you could conclude that the scandal showed Wells Fargo to be fundamentally unscrupulous and therefore unfit for state business, which would be a legitimate motive.
But was Frerichs, instead, grandstanding to politically capitalize on anger over the scandal? Or was he playing cop, which is not his job? Sounds like it. He said at a news conference, “I hope to send the message that their unscrupulous practices are not welcome and will not be tolerated.” That’s for law enforcement agencies and regulators which, across the country, are still pounding on Wells Fargo, as they should. Presumably, Frerichs initially picked Wells Fargo because it provided the best service at the lowest price. That’s his only job, or at least should be.
• Third, Frerichs is using his position in pharmaceutical companies to push them to do what he wants on the opiate crisis. His very specific demands on one company are contained in his letter linked here. That’s an important cause, but is a state treasurer really the one to be drafting and demanding solutions for that crisis?
• Fourth, and most importantly, the Treasurer is authorized to purchase bonds issued by Illinois municipalities. The danger of a backdoor bailout or political favoritism clearly looms.
Last month Frerichs crowed about his purchase of a forest preserve district’s bonds saying, “we understand its value in providing immediate capital support to a local community.” No. That’s not the Treasurer’s job, either, which is only to hold taxpayer money safely and for maximum return. He either over-payed for the bonds or didn’t make any difference, as we explained earlier.
One aspect of the Treasurer’s power to purchase municipal bonds is at issue in the General Assembly’s veto session that starts this week. HB3004 authorizes further borrowing by the RTA and CTA. It also provides that, if the Treasurer purchases bonds issued by those agencies and the bonds default, he may offset against the amounts in default funds that would otherwise flow from the state to the agency.
In other words, it would appear to ease the way for a backdoor bailout and put the Treasurer ahead of RTA and CTA service recipients if bonds he buys default. Gov. Rauner line item vetoed those provisions for those reasons, as he explained here, which will be taken up in the veto session.
What should be done
None of this is to say money with the Treasurer should just be taken away to pay down the bill backlog. It’s Illinois’ last cash stash and should be guarded carefully. Nor is it to say the restricted purposes of funds should be ignored.
Instead, a comprehensive review of all the accumulated funds and the state’s overall cash strategy is in order. Can some of the state’s cash be invested longer term for a higher yield? Can some of the funds be eliminated and the money better used?
Thirteen billion dollars is just too much to be sitting nearly idle.
And the temptation to misuse the power associated with investing so much is too great, which has become evident. Nobody authorized the Treasurer to become some kind of activist hedge fund manager. Nobody is watching over him. Nobody has authority to define what issues he takes on. He should be forced to stick to his primary mission, which is investing taxpayer money as safely and as profitably as possible.
Finally, his purchase of municipal bonds should be watched and restricted very carefully to ensure that taxpayer money doesn’t start getting used for backdoor bailouts and political favoritism.
Mark Glennon is founder of Wirepoints. Opinions expressed are his own.