Like many Carson City residents, as an individual I'm concerned about what current financial and housing market downturns may do to my family's investments, especially the most important one, our home.
However, as city treasurer, I have good news for everyone: The city's finances have not been damaged by the turmoil, but instead have improved during these market storms.
Carson City and other government entities must maintain operating and reserve funds to pay bills as they come due, to finance capital projects and to see them through lean times. One duty of the Treasurer's office is to manage those funds by investing them to assure they earn the highest possible interest rates, while incurring essentially no risk and providing liquidity to let the city pay its bills on time. We must manage our investment portfolios through both good and bad financial markets, and the recent performance shows we are doing so.
An important tool used to accomplish our financial goals is diversification of our holdings by type of investment and by time to maturity. Nevada Statutes dictate the types of investments that are allowable. The types include bonds secured by home-mortgage loans that have become popular in recent years, as well as more traditional vehicles such as U.S. Treasury bonds.
However, nationwide increases in defaults on "sub-prime" home-mortgage loans have recently caused investors to sell or shy away from bonds backed by non-conventional mortgage loans. In a flight to quality, investors moved their money to higher quality instruments, such as short-term U.S. Treasuries, which drove up their prices.
Before those bond-market developments of this summer, however, we sold all of Carson City's collateralized by non-conventional mortgages. We also shifted the bulk of our short-term funds into short-term Treasuries. These two events not only protected Carson's portfolio from losses due to the recent market turmoil, they allowed us actually to benefit from it.
Let me explain why we made these timely and ultimately profitable moves.
Sub-prime loans are those made to borrowers with low credit scores at significantly higher interest rate than those charged to "prime" borrowers. Over the last 10 years, rising home values and declining overall interest rates built a vast lending infrastructure based on "securitizing" these loans. When interest rates began rising in 2004, non-conventional lending increased and a number of sub-prime features were created to feed the lending industry. Low or no down payments, two- or three-year "teaser" rates, followed by higher adjusted rates, 40-year amortization, and interest-only (or in some cases lower-than-interest payments, causing the principal to rise) are some of these non-conventional features.
In the last few years, the housing-price inflation created a classic market "bubble." Many lenders made loans believing that continued home-price appreciation would mitigate any losses on problem loans. Lenders, who make their money on the loan fees, not the interest, sought to close loans and sell them as fast as they could to make more loans.
When home price increases stalled, the assumption that troubled borrowers could refinance or sell their homes when their interest rates reset proved to be too optimistic, and the number of foreclosures increased. Essentially, the structure of non-conventional home financing began to crumble and the bubble burst. The housing downturn was a tip-off on the unwinding of the non-conventional housing-finance secondary market that caused investors to flee such securities for Treasuries.
In May, our portfolio managers advised us to sell all bonds backed by non-conventional mortgages. We did so, and we shifted most of the liquid portion of our portfolio into short-term U.S. Treasuries. We also used an active trading program that has significantly increased our returns on Treasuries. The rates Carson City earned compare favorably with those of other Nevada public entities and with our benchmarks.
I wish I could say that the housing and financial market storms are over and that the value of our homes and other investments will increase continuously. Of course, I can't do so. But I can assure you that Carson City's portfolio is being well managed.
• Al Kramer is a Carson City native and has been the City's Treasurer since 1995.