Wednesday, March 4, 2009

Bloomberg: Hidden Pension Fiasco May Foment Another $1 Trillion Bailout

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I have to admit, while I am aware of the pension liability issue I have not been following this story as closely as I follow all the other areas of duress we've been pointing out the past year and a half. But many on the ball readers have emailed me about the coming disaster that are pensions. Bloomberg has an excellent piece out of which I'll try to put some snippets that best summarize - it is quite lengthy so if this is up your alley I advocate a full read. We should be hearing about this by late this year or early next.

While this is specific to pensions it really is a parallel to almost every major program in the U.S. at both federal and state level. Promises that had no chance to be fulfilled in the name of "kicking the can down the road". Unfortunately multiple roads are converging at a dead end. If the federal government is going to bail these all out it is basically a transfer of wealth from those without these pensions to those that do....many of which are government employees as the vast majority of private enterprises have done away with the pension plan. (this story just deals with the PUBLIC pensions - we are not even touching the underfunded corporate pensions) I don't know when the rubber hits the road and public workers come to the realization that their benefits are out of line with what is happening in the private sector but somewhere out there is a tea party waiting...

But really - what's another trillion among grandkids?
  • The Chicago Transit Authority retirement plan had a $1.5 billion hole in its stash of assets in 2007. At the height of a four-year bull market, it didn’t have enough cash on hand to pay its retirees through 2013, meaning it was underfunded to the tune of 62 percent. The CTA, which manages the second-largest public transit system in the U.S., had to hope for a huge contribution from the Illinois state legislature. That wasn’t going to happen.
  • Then the authority found an answer. “We’ve identified the problem and a solution,” said CTA Chairman Carole Brown on April 16, 2007. The agency decided to raise money from a bond sale. The state hired an actuary, did a study and, on July 17, concluded that the sale of bonds would most likely result in a loss of taxpayers’ money.
  • Thirteen days after that, the CTA ignored the warning and issued $1.9 billion in bonds. (classic!) Before the year ended, the pension fund was paying out more to bondholders than it was earning on its new influx of money. Instead of closing its funding gap, the CTA was falling further behind.
That's just one example!
  • Public pension funds across the U.S. are hiding the size of a crisis that’s been looming for years. Retirement plans play accounting games with numbers, giving the illusion that the funds are healthy. (why is that a surprise? So do our banks and so does our federal government - I mean war has not been an expense for 5 years) The paper alchemy gives governors and legislators the easy choice to contribute too little or nothing to the funds, year after year. (alchemy? more wizards??? like AIG wizards? my gosh - they're everywhere)
  • The misleading numbers posted by retirement fund administrators help mask this reality: Public pensions in the U.S. had total liabilities of $2.9 trillion as of Dec. 16, according to the Center for Retirement Research at Boston College. Their total assets are about 30 percent less than that, at $2 trillion. (oops - just off by a trillion - that can't be good. I am sure the 20% drop in the market since hasn't improved the situation)
  • Typically, public pension funds put 60 percent of their assets in stocks, 30 percent in fixed income, 5 percent in real estate and the rest in riskier investments such as hedge funds and commodities. That mix requires the nonbond assets to earn double-digit gains in order to reach expected rates of return.
  • That lack of funds explains why dozens of retirement plans in the U.S. have issued more than $50 billion in pension obligation bonds during the past 25 years -- more than half of them since 1997 -- public records show. (well that sounds like a reasonable solution!)
  • The quick fix for pension funds becomes a future albatross for taxpayers. (ok not so much)
So let's go back to the logic of the Chicago deal we started the piece with
  • In the CTA deal, the fund borrowed $1.9 billion by promising to pay bondholders a 6.8 percent return. The proceeds of the bond sale, held in a money market fund, earned 2 percent -- 70 percent less than what the fund was paying for the loan.
Aha, that wizardy again... so I BORROW at 6.8% and EARN 2% meaning I (and eventually the taxpayer) LOSE 4.8% a year. Sounds reasonable - let's do more of these. So what do I, and your grandkids get out of this?
  • The public gets nothing from pension bonds -- other than a chance to at least temporarily avoid paying for higher pension fund contributions. Pension bonds portend the possibility of steep tax increases.
Excellent!

This folks is the tomfoolery going on by your leadership across the country.
  • By law, states must guarantee public pension fund debts. “What appears to be a riskless strategy is actually very risky,” says David Zion, director of accounting research for New York-based Credit Suisse Holdings USA Inc. “If the returns on the pension bond-financed assets don’t exceed the cost of servicing the debt, the taxpayers bear the brunt.”
  • The economic downturn gives state legislatures another reason to cut back on funding pensions.
  • Government retirement plans nationwide don’t calculate their shortfalls based on market values of their assets and liabilities. Fund accountants resort to a grab bag of tricks to get by. They set unrealistically high expected rates of return to reduce governments’ annual contributions. And they use smoothing techniques to paper over investment reverses so they make losing years look like winners. Accountants do that by averaging gains and losses, usually over a five-year period -- sometimes for as long as 15 years of investment returns.
  • That means actual results of any one year aren’t used to calculate how much a state legislature contributes, which can delay governments catching up with losses for more than a decade.
Ohh, mark to model techniques - that worked out splendidly for the banks. :)
  • “There are accounting gimmicks in pension land which create economic fictions and which disguise the severity of the real problem,” Kramer says. “Unfortunately, pension board members don’t have much of an appetite for disclosing inconvenient truths.”
Some more quick examples? Texas and California....
  1. The Teacher Retirement System of Texas, the seventh-largest public pension fund in the U.S., reports each year that its expected rate of return is 8 percent. Public records show the fund has had an average return of 2.6 percent during the past 10 years.
  2. The nation’s largest public pension fund, California Public Employees’ Retirement System, has been reporting an expected rate of return of 7.75 percent for the past eight years, and 8 percent before that, according to Calpers spokesman Clark McKinley. Its annual return during the decade from Dec. 31, 1998, to Dec. 31, 2008, has been 3.32 percent, and last year, when markets tanked, it lost 27 percent.
Solution?
  • The best step forward would be for states to negotiate benefits down, increase pension contributions and reduce the expected rate of return, Texas pension oversight board member Rowe says. (keep dreaming)
  • “You’re putting a bigger burden on your children,” he says. “It amounts to a transfer from tomorrow’s taxpayers to today’s employees.”
That's about half the story - you get the picture. If interested in the rest of the madness (specific to New Jersey, and Puerto Rico) read on...


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