It may not be Citigroup, Bank of America or Merrill Lynch but, in terms of impact, Florida’s Local Government Investment Pool has become one of the biggest casualties of the subprime disaster so far.

Overnight, Florida officials suspended withdrawals from the state’s multi-billion dollar cash investment pool after a run from depositors drained it of almost half its value over the past month. It’s a situation that carries a warning for thousands of state, local and other administrations across the US which are facing revenue problems and budget deficits as the housing slump deepens.

As much as $US3 billion was withdrawn on Thursday, taking withdrawals to a total of $US12 billion in less than four weeks (44% of its $US27 billion in deposits).  Nervous state, local and other government groups (such as schools) withdrew their funds after disclosure that the investment pool had hundreds of millions of dollars invested in failed subprime debt.

The suspension of withdrawals means the fund has illiquid investments and cannot guarantee $1 in the dollar to all depositors.  This means the cash-strapped state could have to fund the difference, just as Legg Mason and Bank of America have been forced to make up their difference on their cash funds.

Thousands of schools and local governments across America leave their cash surpluses in state- and county run investment pools.  These are supposed to be similar to cash management accounts and invest in safe, liquid, short-term debt such as US Treasuries and certificates of deposit from highly rated banks.

If these funds begin to fail, there are going to be problems maintaining education, police and a host of other services provided by state and local governments in the US. Many can’t go into deficit by law so will either have to slash spending or lift taxes.

That’s where the subprime crisis and credit crunch gains a big political dimension: not in the presidential race, but in the thousands of state and local races across the country next November.

The Centre for Responsible Lending has estimated a huge impact on state and local governments from the subprime crash over the next three years. That’s something most economists and Wall Street analysts are only just starting to understand.