AUGUSTA – New legislation restricting state investments to those backed by the U.S. Treasury is aimed at preventing losses such as the one last August when nearly $20 million was never returned to the state.

The state treasurer still hopes to gain back part of his original investment and the attorney general’s office has yet to decide whether or not to sue Merrill Lynch for promoting the investment.

But legislation sponsored by Sen. Richard Rosen, R-Hancock, seeks to reform the state’s investment policies.

Rosen’s bill, which faces a public hearing before the Appropriations Committee on Thursday, would restrict the investment choices of the state treasurer to strictly those backed by the U.S. Treasury.

“Just plain old vanilla,” said Rosen referring to the type of investments he thinks the state should make. “My intent is to make it clear from a legislative view that the state’s cash pool policy ought to be extremely conservative. We ought to clarify what the ground rules are.”

State Treasurer David Lemoine said his investments are already conservative and Rosen’s bill would only stifle the state’s earning potential.

“We always work on a very conservative end of the investment scale,” Lemoine said. “If we stay strictly with treasuries, we’ll be unique in the nation having that strict of a policy.”

He estimated that if Rosen’s bill was adopted the state would lose around $8 million in earnings annually. It would also prevent the state from purchasing certificates of deposit from many Maine banks, including Norway Savings, Camden National and Katahdin Trust, as it currently does.

Lemoine said he plans on proposing the state increase its investments in local banks during the public hearing Thursday.

However, Rosen’s bill would prevent the state from making the type of investments that defaulted last summer.

In August 2007, the state invested about $19.9 million in Mainsail II with the expectation of being repaid $20 million after 23 days, in a type of investment known as “commercial paper.”

At the time, Mainsail II met Maine’s investment standards, garnering the highest credit ratings from S&P and Moody’s. But within two weeks, linked to the subprime mortgage meltdown, Mainsail II’s assets were frozen and Maine taxpayers have yet to see a penny of the $19.9 million returned.

Lemoine said Mainsail II still has assets that can be sold and the state’s chances of getting its money back depend on what price those assets are sold at. In a recent release, Mainsail II said it has appointed individuals to find a “refinancing solution supported by secured debt holders” and is not planning to unload its assets in a “fire sale.” The release did not include a potential timeline.

Mark Cyr, a financial analyst in the Legislature’s nonpartisan office of fiscal and program review, said investments like the one the state made in Mainsail II have been commonplace by state treasurers since at least the 1980s.

“Commercial paper” is traditionally attractive to state treasurers because it features predictable returns at a minimal risk and has a quick turnaround rate, said Cyr, who is also a former employee of the state treasurer’s office.

But as financial markets undergo major changes, some traditional investments may no longer be safe bets.

Even though “commercial paper” investments made Maine more than $400,000 per month over the past 3 years, according to the state’s investment reports, all of those gains will be erased if the Mainsail II remains lost.

Since August, the state has made no further “commercial paper” investments. Lemoine said he does not trust any of the ratings’ agencies anymore.

Cyr said credit ratings have been slow in identifying the ever-growing risk in the market.

“The investment community has packaged investments in ways that have ultimately increased risk,” Cyr said. “Some of that risk has not necessarily been reflected in the credit ratings that have come out, and that’s what happened in Maine last August.”

Rosen agreed that the market has played a part in tripping up state treasurers like Lemoine. In addition to Maine, Connecticut, Florida and Montana have suffered similar investment troubles.

“Because of what’s going on in the marketplace, our policies need to be tightened and made more rigorous,” he said. “It’s very difficult for public fund managers to rely on their old policies.”

Rosen’s bill is a starting point for the Legislature, Lemoine said. He agrees that changes need to be made and plans on voicing some proposals during his testimony on Thursday.

Change can be good when it comes to the state’s investments.

From July 2004 until last August, Maine averaged about $250 million a month in commercial paper holdings, or about one third of its total monthly holdings, according to the reports.

But in the past six months, since making no further commercial paper investments, the state has earned more money on average per month. That’s not even bothering to count the $20 million in potential losses.

From July 2004 to August 2007, the state earned an average of $2.3 million per month between account interest and investment returns. Since September 2007, the state has earned an average of $2.9 million per month.

The numbers

$443,000 – average monthly earnings from commercial paper investments, FY05-FY07

$47,000 – average monthly earnings from U.S. Treasury backed investments, FY05-FY07

36% – percentage of Maine’s total cash pool invested in commercial paper, FY05-FY07

3% – percentage of Maine’s total cash pool invested in U.S. Treasury backed investments, FY05-FY07

$694 million – average amount in Maine’s cash pool, FY05-FY07

$2.3 million – average total monthly earnings from July 2004 to August 2007

$2.9 million – average total monthly earnings from September 2007 to February 2008

$69,638.89 – amount of predicted earnings from the Mainsail II investment

$19.9 million – amount spent on the Mainsail II investment that has yet to be returned