By ELI SEGALL
ANNAPOLIS (Oct. 14, 2008)—For the past year, as the economy worsened, Maryland's government had a burst of revenue from an obscure securities lending program. Now, a federal strategy to calm the markets is denting this income, just as Maryland faces a budget crunch.
Officials are not alarmed, as the program brought in roughly $2 million last year, a fraction of the state's overall revenue. But the dip comes amid sweeping budget cuts and a potential $1 billion deficit.
For years, Maryland has lent government-backed securities to banks and other large financial firms. The companies use the loans to insure their own customers' deposits.
Each computerized transaction generates interest for the state. The securities are returned the next day and the state loans them out again, making small amounts of money from each 24-hour loan.
Maryland earned roughly $52,000 from the program last month, a 43 percent drop from the roughly $91,000 it earned in September 2007, said Mary Christine Jackman, director of the Maryland Treasury Office's Investment Division.
In years past, financial firms could insure deposits with potentially volatile securities. But last year, as failed mortgage-backed securities choked the economy, the federal government started requiring U.S. Treasury bonds and other, safer forms of collateral, Jackman said.
One place where firms could borrow these safe securities was the Maryland Treasury Office, which had more than $7 billion of them as of Sept. 30, or nearly all of its investment portfolio.
Due to the spike in demand, Maryland earned more money loaning these securities last fiscal year than the three previous years combined.
Treasurer Nancy Kopp described the intake as "an unusually high amount."
"As important as it was to us, [if] you look at state revenue in general, it is a very small grain of sand on a large beach," she said, referring to the state's annual revenues of roughly $30 billion.
Other states had a similar surge. John Small, director of cash management and investment for the Virginia treasury department, said "extreme demand" for government-backed securities fattened the state's loan revenue. But like Kopp, he expects this income to fall.
The revenue dip can be traced to the collapse, in March, of Bear Stearns Cos., the investment bank, Jackman said. When Bear crumbled, lenders clamped down and it became harder to borrow money, among other problems.
The feds, in an effort to jumpstart the markets, accepted risky securities again as insurance for deposits. They did this because there weren't enough Treasury bonds and other government-backed securities to meet firms' borrowing needs, Jackman said.
But the move slashed demand for the securities Maryland was lending.
"The Treasury started accepting everything from everybody," Jackman said.
Although relatively small, the revenue dip comes at a rough economic time. Gov. Martin O'Malley is expected to propose nearly $400 million in budget cuts Wednesday.
The lending program is not designed to be a hefty source of cash. If a bank borrows, say, $100 worth of securities from Maryland, it must give the state $102 cash for collateral. Maryland then invests the $102, and the next day returns the collateral in exchange for the securities.
The state profits by keeping the interest generated from the overnight investment.
The program generated roughly $560,000 in fiscal year 2007, and less than $500,000 in both fiscal years 2006 and 2005. Bigger returns would require a riskier investment strategy, something the Treasury Office is not legally allowed to do.
The Treasury Office is not the only state agency that loans securities. The State Retirement and Pension System generated $5.1 million in revenue last fiscal year, compared to the $5.8 million the year before.
Capital News Service contributed to this report.