January 6, 2006

Volume 24, Number 1

Online Interview of Portfolio Managers

Washington Update

Economic Outlook

GFOA's 100th Annual Conference

2005 Public Investor Index

Performance Benchmarks

Panel of Economists

Databank

Interest Rate Outlook

Online Interview of Portfolio Managers

T his article is a continuation of an online interview of portfolio managers at JPMorgan Asset Management, MBIA Asset Management, and Fifth Third Bank.

Public Investor: Many local governments maintain a sizable part of their investment assets in a liquidity portfolio awaiting imminent disbursements. In general, what are their options for investing in this ultra-short end of the spectrum (e.g., 60 days or less)?

Exhibit 1: Default/Credit Risk Scale		Exhibit 2: Liquidity Scale
Source: A Public Investor's Guide to Money Market Instruments, GFOA.

Fifth Third Bank: Depending on the specific investment policies of these governmental entities, traditional investment options within this ultra-short spectrum include: securities issued by the U.S. Treasury (bills and notes), U.S. government agencies (discount notes and secondary coupon issues), banks (commercial paper, certificates of deposits, bank notes, and time deposits), corporations (commercial paper and secondary coupon issues), U.S. municipalities (taxable commercial paper, variable rate notes, and coupon notes), asset-backed conduits, and repurchase agreements. Generally speaking, in order to minimize relative risk, investments made within this ultra-short spectrum should be made in “money market eligible securities” as defined by the SEC Rule 2a-7 which governs investments for money market funds.

MBIA Asset Management: Pooled, 2(a)7 managed Money Market Funds likely represent the most appropriate home for state and local governments with imminent disbursements. The ability to tap the liquidity that would be required would be best serviced by such a vehicle and would require the least effort from a state or local government challenged by minimal resources available to invest directly in the market. Certificates of deposits, time deposits, repurchase agreements, and other direct investments are possibilities, but carry risks including interest rate risk, credit risk, and liquidity risk.

JPMorgan Asset Management: Investment options on the short end of the yield curve include commercial paper, certificates of deposit, Treasury bills, agencies, time deposits, repurchase agreements, and money markets.

Public Investor: With respect to liquidity portfolios, are there under-exploited opportunities or overlooked investment options that local governments can take advantage of in the current investment climate?

Exhibit 3: Movement of the Treasury Yield Curve in 2005

MBIA Asset Management: While diversification is any portfolio manager’s goal, when looking at cash management, liquidity and safety should always be the primary goal. Products like extendible notes, secured liquidity notes, short-term asset backed securities are all products which do provide diversification but do not adequately compensate an investor in this environment and also present liquidity risk that is greater than common money market securities. Municipal authorities have been issuing more taxable money market product, but the supply tends to be pretty tight.

JPMorgan Asset Management: There are not many opportunities right now. Everything is expensive. There is so much money in the short-end right now and demand is so high, that there aren't many bargains.

Participating in the online interview were Chris Nauseda from JPMorgan Asset Management, Byron Gehlhardt from MBIA Asset Management, and John Hoeting from Fifth Third Bank.

Washington Update

O ver the last 12 months, Congress, the Bush administration, and the Securities and Exchange Commission (SEC) have worked on issues of importance to state and local governments. Two of these are discussed here: FDIC reform efforts in Congress and the leadership changes at the SEC and the Public Company Accounting Oversight Board (PCAOB). This article summarizes developments in these areas and discusses their implications for state and local governments.

FDIC Reform. Both the House and the Senate passed legislation this year that reforms various FDIC programs, including increasing the amounts covered by deposit insurance. Before Congress adjourned for Winter Holiday recess, the House and Senate reconciled their versions and FDIC reform measures were included in the year-end budget reconciliation bill. However, unlike the Senate, the House did not pass the budget reconciliation before the holiday recess, so it will consider the measure when it returns to Washington in late January.

The version that is waiting final approval by the House includes a new five-year inflation adjustment to the $100,000 baseline deposit insurance amount, beginning in 2010. Also, the insured limit for retirement accounts has been raised to $250,000 from $100,000, the FDIC’s two insurance funds have been merged, and various technical changes were made. Unlike the House version (H.R. 1185), the final reform measures do not include any special provisions for municipal deposits. The House version that passed earlier this year contained favorable language for municipal deposits. Insurance coverage for in-state municipal deposits would have increased to either $2 million or the standard insurance amount ($130,000) plus 80 percent of the deposits over that amount. Unfortunately, due to objections from Senate leaders, the Secretary of the Treasury, and Federal Reserve Chairman Alan Greenspan, House leaders had to yield to a compromise in order to have reform measures enacted this year.

Regulatory Update. This summer, Christopher Cox, Republican congressman from California, became the new chairman of the Securities and Exchange Commis-sion. Cox had chaired the House Homeland Security Committee, the Task Force on Capital Markets, and the Task Force on Budget Process Reform. Prior to being elected to Congress in 1988, Cox practiced venture capital and corporate finance law in Orange County, California.

In recent speeches, Cox has emphasized the importance of investor confidence and the need for greater clarity and transparency to boost investor protection standards. He has highlighted the work of the Public Company Accounting Oversight Board and emphasized the importance of embracing technology to help investors and to enforce compliance with securities laws. Cox’s top priority is enforcement. “We are, first and foremost, the investor's advocate,” Cox told the Securities Industry Association in November. “And rigorous enforcement of the nation’s securities laws is the essential tool in our arsenal.” He has also emphasized the importance of embracing technology in order to help investors and to provide for better review of compliance with securities laws.

On December 2, William Gradison was named acting chair of the Public Company Accounting Oversight Board (PCAOB), replacing William McDonough, who left this fall. The PCAOB was created by the Sarbanes-Oxley Act of 2002 to oversee the audits of public companies in an effort to protect the interests of investors and further public interest in the preparation of informative, fair, and independent audit reports.

Gradison held elective office for more than 30 years, including 18 in the House of Representatives and 13 on the Cincinnati City Council, where he was mayor and vice mayor. He began his career in 1953 as assistant to undersecretary of the Treasury. “… The need for the PCAOB has never been clearer than it is today,” Gradison said. “While progress is being made, there continue to be fresh disclosures of questionable accounting by public companies or problems with the audits of public companies—or both. My intention is to build upon the strong foundation already in place, and I look forward to the work ahead.”

GFOA’s Federal Liaison Center monitors the actions of Congress, the SEC, and the PCAOB as they relate to public investing. Look for more information on the GFOA Web site and in the GFOA Newsletter as it becomes available. If you have questions or comments about these issues, contact Susan Gaffney at sgaffney@gfoa.org or 202/393-8020.

Susan Gaffney is director of GFOA’s Federal Liaison Center in Washington, D.C.

Economic Outlook

Forecasts for 2006

The most recent Federal Reserve Survey of Professional Forecasters predicts that real GDP growth will increase at 3.7 percent in the first quarter of 2006, and then moderate at 3.3 to 3.2 percent for the rest of year. The forecasters predict that unemployment will decline from an average of 5.1 percent in 2005 to 4.9 percent in 2006. They expect that CPI inflation will moderate at around 2.4 percent in 2006 after averaging 3.9 percent in 2005. Over the next 10 years, the survey predicts that the CPI will average 2.5 percent.

The most recent survey of economists by the National Association for Business Economics predicts average GDP growth of 3.3 percent in 2006. The forecasters predict that the Federal Reserve will raise rates to 4.75 percent by the end of 2006, but will reverse course and begin lowering rates sometime in the next two years.

The forecasters also predict that oil prices will decline to $53 per barrel by the end of 2006, and natural gas prices will decline from $12 per MMBtu at the end of 2005 to $9 per MMBtu at the end of 2006. Natural gas prices were elevated due to the disruptions caused by the recent hurricanes. Housing starts are expected to decline from 2.1 million in 2005 to 1.9 million in 2006, and that the annual increase in the national house price index is projected to slow from a rate of 10 percent growth in 2005 to a rate of 4.9 percent in 2006.

GFOA's 100th Annual Conference

GFOA’s 100th Annual Conference will be held in Montréal, Canada on May 7-10, 2006. The theme of this year’s conference will be “A Century of Progress in Government Finance.” The cash management and investing track will feature sessions with tools and techniques to improve the effectiveness of your investment process and the efficiency of your treasury function. Attendees can learn advanced techniques for public investing from experts in the field and find out what is in store for the economy and financial markets in the coming year. In addition, experienced portfolio managers will recommend investment strategies for the current interest rate environment.

On the treasury management side, officials from leading banks will talk about new services and products and discuss what’s on the horizon. Presenters will also discuss new, effective tools for collecting delinquent revenues. More information on the conference is available on the GFOA Web site.

2005 Public Investor Index

2005 Public Investor Index
For your reference, the following table lists major articles appearing in Public Investor during 2005.
January	Cook County Invests $433 Million through Online Auction 2005 Legislative Outlook for Public Investors Break-Even Analysis in Excel GFOA Publishes Book on Banking Services 2004 Public Investor Index
February	Public Investor Interviews Portfolio Managers on 2005 Outlook GFOA Committee Adopts New Recommended Practices
March	Survey Finds Broad Move to Electronic Treasury Management Free Pricing Service for Municipal, Corporate Bonds Goes Online Real-Time Pricing for Munis Now in Effect Bush Budget Continues Deficits, Limits SEC funding Banking Survey Shows Impact of Check 21
April	The Art and Science of Fair Value Pricing The New Worry: ACH Fraud
May	Cash Management: A Crucial Determinant of a Government’s Bond Rating Answering the Bond Market Conundrum
June	What Are Your Fiduciary Responsibilities? Strategies for the Mid-Cycle Inflection Point
July	Leveling the Playing Field: A Review of GIPs (Part I) Getting Started in Commercial Paper
August	Washington Update GFOA Committee Calls for New Mark-to-Market Standards Leveling the Playing Field: A Review of GIPs (Part II)
September	Using Core and Non-Core Funds to Structure Portfolios Will Katrina Be an Economic Hurricane? The Latest in Banking: Remote Deposit Capture Updated Investment Resources on GFOA’s Web Site
October	Beyond Active and Passive Management: Hybrid Portfolio Strategies Fed Sticks to Rate Increases Despite Disasters SEC Relaxes Rules in Response to Katrina PIMCO Chief Sounds Warning on Bonds
November	Portfolio Management Firms Provide Investment Tips Fed Chairman Greenspan to Retire: Bernake Vows to Continue Course Fed Holds Conference on Payment Innovations GFOA Web Site Provides Forum to Facilitate Hurricane Assistance
December	Disaster Preparedness for Treasurers Maintaining Liquidity in a Disaster GFOA Recommended Practice on Business Preparedness and Continuity Guidelines Disaster Preparedness Checklist for Treasurers and Finance Directors Resources for Disaster Preparedness

Panel of Economists

Factors Likely to Pay Key Role in 2006 Economy

This month Public Investor asked its panel of economists what factors are likely to play the most important role in the direction of interest rates over the next six months. We also asked what news or economic data public investors should watch closely over the coming months.

According to John Silvia of Wachovia Securities, the factors that are likely to play the most important role in the direction of interest rates over the next six months will be inflation expectations and post-holiday consumer spending. He suggests that public investors watch consumer confidence, the CPI, and retail sales more closely over the coming months.

Lacy Hunt of Hoisington Investment Management states that the key factors will be inflation and economic growth. Hunt expects that real GDP will slow to around 2 percent in 2006. This slower growth will be the result of substantial tightening in monetary policy that has slowed the growth of M2 to a ten year low and flattened the yield curve. Hunt adds that home equity loans have plateaued since June after surging 40 percent in 2004.

Gary Thayer of AG Edwards & Sons says that the most important factors will likely be Fed policy and inflation. He adds that long-term interest rates are unlikely to increase further if the Fed raises rates one or two more times and inflation expectations remain contained.

According to Carl Tannenbaum of LaSalle Bank ABN/Amro, the critical factor will be how far the Fed will go in its tightening campaign. Keys to understanding this will be post-holiday consumer spending and whether inflation pressure will continue to recede.

6-Month Treasury Bill
2-Year Treasury Note
30-Year Treasury Bond

The Public Investor is published monthly by the Government Finance Officers Association (GFOA), 203 N. LaSalle Street, Suite 2700, Chicago, IL 60601. (312/977-9700; email: PublicInvestor@gfoa.org) Annual subscription rates are $55 for active GFOA members, $70 for associate GFOA members, and $85 for nonmembers. For reprint permission contact GFOA.

The information and opinions printed herein are from sources believed to be reliable, but GFOA makes no guarantee of accuracy. Opinions, forecasts and recommendations are offered by individuals and do not represent official GFOA policy positions. Nothing herein should be construed as a specific recommendation to buy or sell a financial security.