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Florida experience shows how credit crisis can shatter American economy

The credit crisis is not someone else's problem, Florida can prove it - plenty of people seemingly far removed from the financial turmoil have been hard hit by its impact.

Nothing illustrates that more than the decision last week by officials in Jefferson County, a mostly rural slice of the state's northern panhandle, to not pay electric, food and gas bills so that its teachers would not have to miss a paycheck.

That $500,000 (341,320 EUR) in bill juggling was needed because the supposedly conservative state-run investment pool that minded the district's money temporarily shut off access to the funds after it made some extremely bad bets on its mortgage-related investment choices.

This mess in Florida may only be the tip of the iceberg, and could rob Christmas for many unknowing Americans.

"Contagion affects the innocent," notes David Kotok, chief investment officer at the portfolio management firm Cumberland Advisors in Vineland, New Jersey. "What is happening here is the outcome of dysfunctional credit markets."

For the first half of this year, there was some hope that the mortgage meltdown would be contained to a limited number of defaults on home loans and a temporary pullback in new home construction.

Then this summer, lending standards for mortgages to corporate borrowing began to tighten, and trading in the riskiest corners of the credit markets became paralyzed. That sent stocks plunging from record highs as worries mounted over the extent of this credit-market turmoil.

Those most affected by all this have seemed to be the financial institutions that had packaged the subprime loans into complex securities. The value of such debt suddenly plunged, leaving them with big losses on their books.

This mess is getting bigger and broader, however. The subprime woes are fanning out to people and places that never saw them coming.

Enter Florida. A state-run cash-management fund, which held public money from school districts and local governments, was thought to be highly liquid and safe - as recently as mid-November, when its administrators said that there was minimum risk due to the credit-market turmoil.

Things didn't stay rosy for long. It turns out that Florida's Local Government Investment Pool owns more than $2 billion (1.37 billion EUR) in downgraded and defaulted debt tainted by the subprime mortgage collapse.

Its asset-backed commercial paper holdings, which carried top ratings from Standard & Poor's, Moody's Investors Service and Fitch Ratings as recently as August, was downgraded after there were declines in the value of its collateral.

Word of such illiquid investments spooked the funds' investors in recent weeks, setting off a multibillion dollar run that depleted the pool's assets from $27 billion (18.43 billion EUR) to $14 billion (9.56 billion EUR) in no time. To control the chaos, state officials suspended withdrawals, leaving many locales scrambling to pay their bills.

Hal Wilson, chief financial officer of the Jefferson County school district, said that with its $4.1 million (2.8 million EUR) in the fund frozen, he had to decide whether to pay 220 teachers or to put off many of the district's vendors, who he noted "have families they have to feed, too."

Those in Florida got a bit of relief when top state officials allowed local governments to make limited withdrawals starting Thursday. More than $1.1 billion (750 million EUR) was retrieved from the fund.

Florida officials also decided this week to quarantine the worrisome investments in a separate fund and the head of the agency responsible for the fund stepped down, too.

Wilson still has worries, though. On Thursday, he withdrew the $2 million (1.37 million EUR) maximum that can be taken out of the fund without penalty to cover the immediate needs for his district, but remains concerned about being able to pay the schools' bills. Due on Dec. 20 is a 5 percent pay raise for teachers, retroactive to July, that his district had negotiated earlier this year.

Florida is not alone. In Montana, Connecticut and Maine, there are concerns over the debt exposure of state-run funds. And across the world in Norway, four remote towns lost millions of dollars due to their complex debt investments.

Standard & Poor's maintains ratings on 75 local government investment pools in 26 states, not including Florida. Of that total, 17 have investments in asset-backed commercial paper and nine have exposure to structured investment vehicles - two areas that have been badly battered by the subprime meltdown.

Many of these so-called safe investment funds were chasing higher yields, and were willing to ignore the risks to get them. Now it looks like many of us may get stuck with the bill.

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