By John Thackray

The conventional wisdom is that the political opprobrium around derivatives is lifting. Maybe so. But not in Ohio, whose legislature last month passed the severest of any state's prohibitions on derivative investments by local government bodies. Mastermind of this law, which had been 17 months in preparation, is Ohio's state treasurer Kenneth J. Blackwell-well-known on the national lecture circuit as a radical critic of derivatives. And his message, or mantra, is this: "Public portfolios shouldn't hedge risk-they should be risk averse If you have no risk, or low risk, you have no need for derivatives." (From a speech by Blackwell last April to the Jerome Levy Economic Institute.)

Blackwell put his stamp on Ohio despite the considerable lobbying power fielded by the Securities Industry Association (SIA) and several listed exchanges. To the latters' dismay, the new law uses the broadest possible definition of derivatives and comes down against reverse repurchase agreements and leveraging-even against "purchasing an investment where there is not a reasonable expectation it will be held to maturity."

The law's other restrictions: all municipalities have to write up an investment policy, which their broker-dealers have to sign and agree to abide by. "This is contrary to the prevailing view of the nature of the relationship between dealers and counterparties," complains a spokesperson for the SIA. "It forces a certain degree of fiduciary status on the dealer just for executing transactions." Blackwell's response: "Where the broker-dealers initiate the sale they are going to be part of the accountability structure."

Another prohibition: the issuance of taxable notes for arbitrage purposes, a practice that contributed to $114 million of losses by a local government investment pool (such pools are now banned) in Ohio's Cuyahoga County in 1994. Some 20 other political subdivisions in Ohio lost money through risky investment practices, which accounts for another of Blackwell's reforms: that all public funds managers attend annual investment courses given by Blackwell's staff.

Compared to anti-derivatives legislation passed last spring in Texas, this is a quantum leap in severity. Texas principally targeted the more volatile tranches of CMOs while permitting conventional derivatives instruments. (There are signs, too, that Texas regulators may be willing to compromise down the road.) In Ohio the politically ambitious Blackwell is clearly bent on using this law to spoon-feed his arch-conservative investment philosophy.

Some of his critics suspect a hidden motive. If municipal treasurers are assaulted with enough red tape they many may simply throw up their hands and elect to outsource their investments to the state's investment pool, STAR, which is under Blackwell's direction and, incidentally, exempt from this law. Also exempt are the treasuries of big cities like Cleveland and Cincinnati, where Blackwell once was mayor. Municipalities may also give money to Blackwell to manage because his greater freedom may earn higher rates of return. Result: Blackwell's empire would grow. In an interview he doubted that "this would be a commonplace response to these new controls. Municipal finance directors and country treasurers' associations have both spoken to their need for, and appreciation of, this bill."

As happened in Texas, there is grumbling among broker-dealers that maybe they should pack their bags. "Go to it," is Blackwell's response to this threat. He says: "I'm sure there are those out there of faint heart. Maybe some hand-wringers will get out of the market and leave more of it for others. But will Ohio become a broker-dealer wasteland? I don't think so."