Back in in 2008/2009, one of the largest insurance companies in the world, American International Group (AIG), basically imploded.

Self-inflicted torpedoes took down the huge company, including a massive credit default swap portfolio and complex securities lending transactions.

AIG had some of the most complicated financial statements on the planet, but there were some simple cues to impending doom.  For example, the number of times the term “credit default swap” appeared in the company’s annual report jumped sharply when the report for 2007 was released in early 2008, well before the stock dove later in the year.

Hopefully, the financial statements for the state of Illinois aren’t giving us a similar cue.

The chart below shows the number of times the phrase “securities lending” appears in Illinois’ “Comprehensive Annual Financial Report” (CAFR) from 2005 to 2013.  The references spiked sharply higher in 2009, amidst broader calamity in a financial system including counterparties for Illinois on these transactions.

Bergman chart 1 11-25

In turn, the chart below shows the dollar amount reported for securities lending collateral in the assets on Illinois’ Statement of Net Position.  This program has risen dramatically since 2008, with over $6 billion in assets now reported.

Bergman chart 2 11-25

Rapid growth in financial assets like these can be a sign of trouble.  The fact that Illinois accelerated its use of securities lending beginning in 2008/2009 could be another red flag, given that year was also the onset of the worst financial crisis since at least the Great Depression.

Securities lending programs can also be managed well, with good risk management in place.  When coupled with the large increases in derivative liabilities now being reported by the state, however, the growth in securities lending activity can also be discomforting.

Hopefully, conditions in securities lending aren’t part of the information that has been delivered to Governor-elect Bruce Rauner after he was elected.  Yesterday, on the heels of reviewing this information, the new Governor described Illinois finances as “stunningly bad.”

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