Some of the investments, all of which had fallen below purchase guidelines, were in a fund where local governments and school boards stashed operating funds until they were needed.
Over the following two weeks, as word got out, Florida municipalities yanked $10 billion from the Local Government Investment Pool in a classic run-on-the-bank scenario. Only an emergency freeze on Nov. 29 stopped the stampede for the exits.
Last week, the executive director of the State Board of Administration, Coleman Stipanovich, resigned under pressure. The state hired BlackRock, a Wall Street investment management firm, to guide the state out of the mess by segregating the troubled investments into a separate fund and limiting withdrawals from the healthy fund while it works out the problems.
And the problem is far from over: Alex Sink, the state's chief financial officer, who had pressed Stipanovich for the Nov. 14 finacial update that triggered the run, plans to ask auditors to probe what happened.
Local officials, scrambling to replace the missing cash with other funds, are wondering whether state laws were broken. Finger-pointing has begun, and some local elected officials are contemplating filing lawsuits to recover money they invested with the state.
''If the shoe were on the other foot and I, as elected clerk of the court, had done the same thing, the governor would be removing me from office,'' fumed Jeff Barton, who has been the Indian River clerk of the court for nearly 20 years.
It's unclear what losses the fund might ultimately face.
''There are so many unknowns, it's difficult to guess,'' said Christopher Stavrakos, BlackRock's co-head of cash portfolio management. ``It depends on the liquidity in the market. Right now, the market is obviously stressed and dislocated.''
THE UNEXPECTED
The rising anger and frustration among local officials contrasts sharply to the intent of the Local Government Investment Pool when it was set up 25 years ago: to help cities and counties by providing a safe place to stash their cash until they needed it to pay bills.
The thinking was that some cities and counties lacked the sophistication to invest wisely. So, the State Board of Administration, which also handles the state's pension fund, was put in charge.
Many local governments used the pool as a sort of money-market account. But in order to boost the amount of money the fund was paying out, investment managers decided to shun low-paying investments like U.S. Treasuries and opted in favor of investments that pay better -- but carry a higher risk.
The strategy seemed to be working. For the first six months of this year, the local pool was generating a 5.39 percent annual rate of return.
''It was exceeding benchmarks,'' said Michael Geoghegan, Broward County's director of finance and administrative services. ``It turns out it was a little too good.''
In fact, Florida's local pool was investing more aggressively than many of its peers. Although the credit agency Standard & Poor's doesn't rate Florida's pool, it does rate 75 local-government pools. Among those, only 17 are allowed to invest in the type of investments Florida chose: asset-backed commercial paper, which is short-term company debt. Only nine of those 17 can invest in structured investment vehicles, or SIVs, which are complex instruments that are also part of Florida's troubled portfolio.
While the State Board of Administration told the cities and counties that it was investing in such securities, its newsletter to the nearly 1,000 investors last summer also carried reassuring words: ''As always, our investment process emphasizes safety and liquidity over yield,'' wrote Michael Lombardi, the director of short-term investments.
During normal times, such investments have proved safe. But during the summer, the collapse of subprime mortgages began to spread widely through the financial world. The investments, bought from top Wall Street firms such as Lehman Brothers and initially given solid ratings by credit agencies like S&P, began to go bad.
In mid-August, state investment managers learned that holdings in Countrywide, the giant home lender, had been downgraded by credit agencies. The State Board of Administration's own rules require that when that happens, the investment must be sold or a ''justification'' must be approved by senior officials at the State Board of Administration.
The verdict from board officials: It was better to keep the investment.
''We are comfortable that Countrywide has, and will continue, to fund their operations in the foreseeable future and will successfully emerge from this unusual market,'' said a ''justification'' report.
The situation, however, worsened in October, when several other holdings in the state pool were also downgraded by rating agencies.
On Halloween, the State Board of Administration issued another newsletter that disclosed the downgradings, saying the state had renegotiated with some companies on when it would be paid back. But the problems were regarded as ''isolated,'' the newsletter stated.
Those problems didn't remain isolated. A day later, Sink demanded that the board report to its trustees -- Gov. Charlie Crist, Sink and Attorney General Bill McCollum -- about any unknown risks in state investments.
Stipanovich, the brother of former Gov. Jeb Bush's campaign manager, J.M. Stipanovich, and the board's executive director for five years, offered reassurances, noting that Florida was still receiving payments on the downgraded investments.
EXITING WITH ALARM
But as news of the pool's woes spread, many local governments bailed out.
In Miami-Dade County, officials scrambled to pull out $512 million -- every cent they had in the pool -- between Nov. 16 and Nov. 26.
''We weren't as concerned about the investments as we were that there would be a run on the bank,'' said Rachel Baum, Miami-Dade's finance director. ''What local governments wanted to hear were some assurances that we wouldn't lose the principal.'' No such assurances came.
On Nov. 26, Baum removed $200 million, and the next day, the final $182 million -- just two days before the freeze.
Broward County government similarly escaped unscathed, pulling out some $200 million about Nov. 15, soon after officials learned of the fund's soured holdings.
''We just got our money out as fast as we could,'' said Geoghegan, the Broward finance chief. ``Some other governments didn't like that, but you got to do what you got to do. It's public money.''
With the fund bleeding billions, Sink stepped in again, demanding an emergency meeting of the State Board of Administration's trustees. At the Nov. 29 meeting, Stipanovich offered his plan: Have the state vow to protect any assets of local governments with money from Florida's massive $140 billion pension fund.
''If we don't do something quickly, we're not going to have an investment pool,'' Stipanovich pleaded.
His plan was soundly rejected. Sink instead pushed to freeze the entire investment fund, a move that sent reverberations across the state as cities, counties and schools were cut off from their own money.
PAYROLL AT RISK
Leon County schools, for example, had to rush out that same day and borrow $10 million in order to meet their end-of-the-month payroll.
''I was very disappointed in the way we were treated on this,'' said Jackie Pons, the Leon County school superintendent. ``If you put someone's payroll in jeopardy, timely notice needs to be given.''
Sink argues that couldn't be done, because even more government bodies would have withdrawn their money.
''When you have a run on the bank, you have to draw a line in the sand,'' Sink said. ``It's not fair for those investors running to get out to leave the others.''
But the state's action may wind up sparking a fight. Some local officials are questioning the legality of blocking access to local tax dollars or forcing local governments to pay a 2 percent penalty if they exceed a withdrawal limit. Currently, investors still in the pool can withdraw only 15 percent of their holdings, or $2 million, whichever is greater, without paying the penalty.
Some just want the state to apologize and promise that it will use state money to help. ''If the fund were guaranteed, then people would stay in,'' Pons said.
That doesn't appear likely. Senate President Ken Pruitt told local officials in Indian River County last week that cities and counties knew the risks when they invested with the state.
''The state provides a service. When you got higher yield, you got higher risk,'' Pruitt said during a heated exchange with Indian River Clerk of the Court Jeff Barton. ``No one had a gun to your head.''
