CHARLESTON, W.Va. -- The West Virginia Investment Management Board has been shackled to a $150 million loan for state prisons, despite attempts to wriggle free of the state law that mandates the loan.
In what appears to be a first for the U.S. pension industry, the investment board will loan the money over 25 years to the state's Regional Jail and Correctional Facility Authority.
The loan carries unusual terms, paying 10 basis points over the rolling five-year annual return of West Virginia's fixed-income portfolio, with a minimum of 5% annually.
The loan was made over the objections of the state's attorney general -- who called the loan "unconstitutional" -- and despite concerns about the fiduciary liability of the investment management board.
"It's very uncommon" for a state to mandate specific investments of any kind, much less in prisons, said Stephen L. Nesbitt, senior vice president and principal with Wilshire Associates Inc., Santa Monica, Calif.
In recent times there have been efforts to foist sports stadium financing onto pension funds, Mr. Nesbitt said. And in the 1980s, in-state venture capital funds were proposed as mandated investments for pension funds, he said.
But prison financing is a new one to him.
The prison loan was the creation of state legislators and Gov. Cecil H. Underwood, who also is chairman of the state investment management board.
The money will finance the construction or renovation of regional jails and correctional centers, where state officials are seeking to stem overcrowding.
Spokesman Rod Blackstone said the governor was "somewhat content" in getting the law passed by the Legislature and approved by the Supreme Court.
The law requiring the loan was something Gov. Underwood worked out with the Legislature, Mr. Blackstone said.
Because state law limits the ability of the Legislature to borrow money or raise taxes, state officials saw the pension fund maneuver as a way to essentially do both, said West Virginia Attorney General Darrell McGraw.
But before the board would comply with the law, a stamp of approval was sought from the West Virginia State Supreme Court of Appeals.
"Our board rejected it. We didn't think it was a . . . responsible thing to do," from a fiduciary standpoint, said H. Craig Slaughter, executive director for the investment management board.
Even with the law in place, board members were concerned about fiduciary liability, Mr. Slaughter said.
A "friendly" lawsuit was filed, the Supreme Court agreed to hear the case, and the court recently upheld the law, in a 3-2 vote.
The loan will be made over the objections of Mr. McGraw, who said it was a confiscation of participant assets.
Mr. McGraw filed an amicus brief with the state Supreme Court arguing as much (although his office had lawyers representing the other side of the case, as dictated by law). The law is "not only unconstitutional, but an unconscionable betrayal of all public employees who depend on the security of their retirement system," the brief states.
The decision to tap the state pension system for operating purposes is "fraught with peril," Mr. McGraw said in an interview.
"It's not good public policy, it's not good public finance," he said.
Because employees contribute their own money to the fund, Mr. McGraw said, the Legislature is effectively taking those assets in mandating the loan.
Moreover, state taxes are being used to support a loan that should be voted on by the public, he said. The state's constitution requires all state borrowing to be done only with the approval of voters.
To get around that, the law allows the prison system to borrow from the pension fund, and tap into funds earmarked for general revenues to pay for the loan, he said.
Others were concerned that the loan will set an unhealthy precedent for state government.
"It's a step on the slippery slope that you don't want to take," Mr. Slaughter said.
Jerry Simpson, assistant treasurer for the state, said he too fears the state would return for additional money from the pension assets.
"What happens if the Legislature comes back" and does it again for some other purpose, Mr. Simpson asked. State Treasurer John Perdue, a West Virginia Investment Board member, was unavailable for comment.
As for the loan's terms, the basic idea is that the loan will pay interest tied to what the board had earned in its fixed-income portfolios over a five-year period, plus a small premium.
While those terms might make sense politically, from an investment standpoint they are unusual and difficult to evaluate.
"It's arguable" whether the fund would be better off with or without making the loan, Mr. Slaughter said.
The loan's terms of paying a current coupon rate based on a previous return is highly unusual for the fixed-income industry.
Moreover, the investment is less liquid than a typical fixed-income security would be.
A municipal bond portfolio manager for a mutual fund company, who spoke on the condition she not be named, said the loan "would be very difficult to evaluate."
Paying a current coupon based on historical returns doesn't make sense, she said.
"I would probably want to peg it off of something else," such as a U.S. Treasury security, she said.
Nevertheless, the investment management board probably will comply with the law and begin the process of lending the money to the prison system, Mr. Slaughter said.
Mr. McGraw said it appears nothing more can be done to prevent the loan.
Added Mr. Simpson in the treasury department: "This is a crisis (for the jail system). There's no doubt about that."
