Should Public Pension Plans Go Toxic?

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May, who was plugged in by phone during the Bair meeting, is also actively looking at investing in the Term Asset-Backed Securities Loan Facility, or TALF, created by the Federal Reserve Board in November to support investing in asset-backed securities and small-business loans. May says estimated returns on TALF funds of between 15% and 20% are extra enticing because they come with a government guarantee: "If this is successful, not only do we reap returns on the TALF investments, but if it gets the economy moving, that would be good for our other investments, too."

PPIP: "Very Early in the Process"

May has been listening to pitches from fixed-income managers such as Pimco and Alliance Bernstein (AB), which are putting together deals of 3½ years in length. These firms would assess, choose, and manage the TALF assets—collecting payments on them while investors such as the public funds would get a cut of the upside for having loaned capital for the initial purchase. May says he can minimize his risk by not putting too high a stake into these assets and by sticking to AAA-rated investments, a grading he expects credit rating agencies are now tougher about doling out than they once were.

But the program Bair discussed Apr. 3, the Public-Private Investment Program, is not nearly so far advanced. Sherry Reser, a spokeswoman for CalSTRS, California's $114 billion teacher's pension fund, confirmed that her fund's staff was in on the call, but described the meeting as "very exploratory." CalSTRS is now moving 5% of its total portfolio from equities to private equity, real estate, and fixed income, with the goal of finding and investing in solid assets from distressed sellers. "The PPIP may certainly meet our criteria," Reser says. But it's "very early in the process. We're definitely in a wait-and-see mode. We think we're uniquely positioned. We have staff geared up, a process in place, and we are ready to take advantage of the opportunities that do come up in these troubled times."

To guard against going too far out on a limb, CalSTRS' upper-level investment staff has put in place a system called the Devil's Advocate, in which one staffer tears any prospective investment apart, posing hard questions. "Because of these potentially toxic assets," says Reser, "we want to make sure the only distress is the sellers'."

With Christopher Palmeri in Los Angeles.
Byrnes is a senior writer for BusinessWeek.