LATE UPDATE: An earlier version of this post misidentified New Mexico State Investment Council portfolio manager Kay Chippeaux as being Frank Foy's replacement; Foy had held various titles including chief investment officer at the state's Education Retirement Board.

In June 1997 Tom Flanigan, the chief investment officer of the California State Teachers Retirement System, wrote a letter to his old mentor, then-SEC chief Arthur Levitt. He was under political pressure, he said, to gamble with teachers' savings. The state comptroller was demanding he allocate a bigger portion of the fund to venture capital firms and hedge funds in what he thought to be an overheated market.

Meanwhile, hedge funds and private equity firms were hiring politically connected "placement agents" to descend upon his board of directors, who had final approval over his investment decisions. He had just watched the Texas investment firm Hicks, Muse, Tate and Furst secure a $100 million investment from the state employees' general retirement fund CalPERS after paying a $750,000 "finders fee" to a former board member and longtime Los Angeles politico named Alfred Villalobos. Villalobos had a questionable history with Hicks -- as a board member he'd already approved another $100 million investment in the firm on the advice of the fund's paid adviser Chris Bower. Nine months later, Bower sold his two-year-old yacht to Hicks founder Tom Hicks for a $45,000 profit. And there was other smoke around the deal, if no clear fire: Villalobo, for one had just filed for personal bankruptcy over gambling debts. And the board had initially rejected the deal -- when another LA politico on the board, a labor leader named Jerry Cremins, changed their minds. There was something "unseemly if not unethical" going on, Flanigan wrote. The SEC proposed rules regulating the placement agencies.

A few months later, Flanigan was sacked.

The SEC's proposals went nowhere. In 2001, Flanigan was hired to run the Connecticut state employee pension fund after the former state treasurer was indicted in another play-to-play scandal. (Seven weeks into the gig, Flanigan was sacked again -- this time for trying, he claimed, to stop a massive secret sale involving bond sales by a firm which had already been indicted in another case.)

Frank Foy can relate. Until 2006 he managed the New Mexico teachers' retirement fund, and according to a whistleblower lawsuit he filed against the state, he maintained a strict policy against investing any money with managers who made political contributions. He started at the fund in 1992 and was promoted to chief investment officer in 1996. But when Governor Bill Richardson took office in 2003,things changed. Bruce Mallot, the Education Retirement Board chairman and Richardson campaign treasurer, started getting more aggressive with the pension's money -- as his accounting firm racked up $7.8 million in state auditing contracts. "It had become apparent," the complaint reads, "that in some instances [investment decisions] were being tainted by political considerations and contributions." By 2005, the complaint says, Foy was regularly coming into conflict with the board. Mallott advised him to be a "team player."

Rather than face Flanigan's fate, Foy arranged in 2006 to demote himself to deputy, a position from which he could not be fired without cause. That same year, he started getting calls from a firm called Vanderbilt Capital Advisers, which wanted the fund to invest in a mortgage-backed collateralized debt obligation, or CDO. If those three letters mean anything to you, you have an idea where this is headed. But Vanderbilt's was a very special kind of CDO.

After investment banks pool mortgages together into CDOs, they split them up into "tranches" of quality, of which the highest-rated get first dibs on interest payments. Generally in such deals, only the highest-rated tranches are sold to investors. But what Vanderbilt was peddling was the lowest-quality "equity" tranche -- "the residue left over after investment banks assemble assets and securitizes them," as the complaint puts it. Equity tranches were also known as "toxic waste." The investment banks did not bother paying rating agencies to grade them, because they generally didn't bother trying to sell them.

Vanderbilt estimated the tranche would deliver 20% annual returns; Foy could not see how. The Board voted 4-2 to invest $90 million in the CDO. It would not be the last for the state: Kay Chippeaux, who managed money for New Mexico's State Investment Council (and contributed to Bill Richardson, told Bloomberg that by April of that year her fund had $225 million invested in "equity" tranche CDOs and its board had voted to invest $300 million more. In May the ERB received its second and last interest payment from Vanderbilt, the two of which totaled $3.7 million. In August the fund received a letter from Vanderbilt blaming "cash flow" problems for a suspension of interest payments. The rest was gone.

That December Foy was accused of sexual harassment in what he claims was a ploy to get rid of him; he was found guilty on three charges but claims the charges were fictitious. He was demoted and eventually all but forced to retire, the lawsuit claims. Whatever one makes of charges against Foy, the very questionable investment he notes, speaks for itself. Banks pawned off "equity tranches" on a multitude of public pension funds during the height of the height of the bubble, but no fund's exposure to the risky assets even approached New Mexico's. (Although CalPERS looks like it was the second most aggressive toxic waste acquirer.)

Foy never figured out who got what out of the deal, save for the 20 banks and asset management firms that collected fees to put it together. But the son of one of Richardson's closest associates turned out to be the "placement agent" on the deal -- and 23 others that netted him more than $11.5 million in fees.

And that son, it probably wouldn't surprise Tom Flanigan to learn, sometimes collects fees through a placement agency owned by the son-in-law of that persuasive CalPERS board member Jerry Cremins -- who is in turn accused of participating, along with the yacht-flipping consultant Chris Bower and a host of other politically-connected professional pension fund skimmers, in the $35 million state-run conspiracy to defraud the pension fund in New York.

New York finally got around to banning hedge funds and private equity firms from paying "finder's fees" for investments in the pension fund -- but not before an assortment of politicos and Wall Street banks succeeded in assembling an extensive Rolodex of quid pro quo-inclined money and managers. In many cases, that same Rolodex was deployed to peddle interest rate swaps and other risky derivatives on cities, states and public works programs.

While most of Wall Street's worst abuses were carried out by people sufficiently divorced from the consequences of their actions -- by screens and spreadsheets and the detaching effects of "securitization" -- to perceive them as victimless crimes, the ever-expanding pay-to-play scandal involves a much more direct plundering of the public sector and the retirement funds of those who work within it to enrich Wall Street. Its complexities are still mind-numbing, but this is only financial scandal where you'll find characters like Rod Blagojevich. We'll be introducing you to some more of its boldface names over the coming days.