A great read on Reuters about America's largest pension fund, CALPERS. Talk about too big to fail - the Californian taxpayer is on the hook is CALPERS cannot pay out the avalanche of promises to California's state works... and we know what that means. We're all on the hook for it... see stimulus plans passed as de facto state budget gap fillers... shhhhhh, it's a secret (wink wink).

There are so many long term issues in America I sometimes get lost in the morrasse. We don't even have time to really focus on the pension issues but we've mentioned it a few times. [Apr 5, 2009: AP: $1 Trillion Hit to Pension Funds Could cost Taxpayers, Workers] [Oct 24, 2009: WSJ - Pensions Funds Taking Serious Hits]

As I wrote in March [Mar 4, 2009: Bloomberg - Hidden Pension Fiasco May Foment Another $1 Trillion Bailout]

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.

[Bloomberg] 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. The paper alchemy gives governors and legislators the easy choice to contribute too little or nothing to the funds, year after year.

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.

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. The quick fix for pension funds becomes a future albatross for taxpayers.

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Actual future US representative in training: kicking a can --->

One fun fact specific to California [Aug 11, 2009: LA Times - Amid Cost Cutting, Los Angeles City Pensions Continue to Soar] - in 5 years the potential exists that 1 in ever 3 dollars in receipts will be going to fund pensions... leaving 2/3rds for everything else!

One recent projection warned that the share of the city general fund receipts required by two large pension funds would jump from 15% this year to 33% in 2013-14.

Other fun data

Here is a great story from the LA Times showing the complete disassociation between reality and what is going on in the public sector. As I noted last week, public and pseudo public jobs (of which healthcare has now become with the massive subsidies - you can also include education here) is now 1/3rd of our entire workforce... and it's growing like a weed. So 2/3rds are subsidizing 1/3rd ... today. And it will only grow from here. When is the breaking point? 50/50? When 1/3rd outside government is supporting 2/3rds inside government / healthcare? I don't know. But it will end badly.

Collecting nearly $318,000 a year, the former head of Los Angeles' Department of Water and Power tops a list of 841 city pension recipients paid six-figure benefits, according to newly obtained records.

We should never, ever design a pension formula that provides more for a person when they retire than when they are working. It defies any common sense, said Marcia Fritz, vice president of the California Foundation for Fiscal Responsibility, a nonprofit pension reform group headed by former GOP Assemblyman Keith Richman.

But that's what we're finding in some school systems and public safety agencies, Fritz said.

(in greater California) The group has publicized more than 5,000 names of state and local government pension recipients across the state collecting more than $100,000.

Boo yah taxpayers.... boo yah. The Reuters article is very involved so I'll just snip some of the most interesting data points - remember, just as with our banking industry the problem to all our solution is some accounting tricks. Once we got rid of mark to market (i.e. true value) in the banks, all our problems went away... in the pension world if you have shortfalls you just begin projecting wonderful long term gains... if you need 8% returns in the long run to not go into freefall - you say you will make 8%. Problem solved! Kick the can...

Via Reuters:

  • Red flags about the growing riskiness of Calpers' portfolio also went unheeded. A consultant warned Read in December 2007 about the size of the fund's commitment to private equity, but the push went on.
  • For a while, Calpers looked smart under Read, hitting a peak value of $260 billion in October 2007 as it borrowed money to boost returns (sound familiar?) and moved into sophisticated collateralized debt obligations, land for residential real estate, as well as commodities. (perhaps they should be renamed Goldman CALPERS?)
  • But as the financial crisis unfolded last year, Calpers lost $100 billion, more than a third of its value, (sounds like a great conservative widows and orphans type of fund) tumbling to $160 billion a year and a half after the high.
  • The other thing it lost was its gold plated reputation, founded on steady returns, pioneering new investments and policing public companies as an activist shareholder. Smaller rivals who were more conservative lost much less. (but why be conservative when the CA taxpayer, and by proxy all American taxpayers backstop you - you know you are too big to fail, so please speculate at will.)

So what's the solution when the risk egg blows up in your face? I know, I know!! Oh pick me! (my hand is raised in the air, virtually) You reduce risk so you don't repeat those errors. (gosh, that was an easy one).

Errr... wrong.

  • Calpers has not retreated, though -- just the opposite, in fact. As the entire pension industry questions what level of risk it should be taking in the aftermath of last year's financial meltdown, Calpers in June increased its target for venture capital and private equity -- what the fund's advisor itself called the highest risk, highest reward bet -- to 14 percent of overall investments, up from 10 percent.
  • Calpers has the reputation of being the gold standard of pension investing, largely by the virtue of its size. But the reality is very different, said Edward Siedle of Benchmark Financial Services, a pension fund investigator and investment consultant.
  • The new strategy by the board was nothing more than a high-stakes attempt to dig itself out of a hole, he said, reflecting the view of many critics. Since their liabilities have grown and their assets have shrunk, they have concluded that they need to take more risk to close the gap, he added.
  • In all likelihood this risky gamble will not end well, Siedle said.

Or as they say in Las Vegas... the strategy is to double down after you've taken a big hit. My sources tell me this usually works our splendidly. (sarcasm) But if it doesn't? Again, not to worry - that is where you, dear readers (at least in America) come in.

  • Voters in California are beginning to understand that they will have to make up any shortfalls. Rating agencies are reviewing municipal debt with an eye to what billions of unexpected liabilities could do to fragile budgets.
  • And in the past weeks, a scandal about how former Calpers officials lobbied to place investments has drawn renewed attention to the obscure world of managing pensions.

And...

  • One reason Calpers invests so much is that it has to: $200 billion, roughly twice the state of California's annual budget, is a lot to invest.
  • Critics say the board lacked more than fancy computer models. It lacked common sense.
  • Flanigan sees history repeating itself as Wall Street accommodates the appetite at public pension funds for more risk in the search of home-run profits to make up for losses over the last two years. (translation - Wall Street sells snake oil, investment funds buy it. If investment fund blows up, taxpayer pays for it as they are liable. If Wall Street firm blows up, taxpayer pays for it as investment bank is too big to fail. Do you notice a common thread? Hint: it rhymes with waxpayer. Heads they win, tails they still win)
  • Calpers is aiming for an annual investment return target of 7.75 percent, in line with returns in recent go-go decades. Lawrence Fink, chief of gargantuan asset manager BlackRock told the Calpers board in July he didn't think the fund would hit its target. I think it's going to be subpar for many years, he said, suggesting that cuts in benefits be considered.
  • Shortfalls add up fast. Taxpayers are on the hook for about $2 billion for each percentage point investments are behind target, said Rick Roeder, an actuary who has consulted for public pension funds. And the targets are high, he added. Calpers has relatively optimistic assumptions about investment returns compared to other public funds in the state, Roeder added.

And to top it off....

  • Politics only adds to the risk at Calpers.
  • Stacking the board with political representatives of beneficiaries only makes things worse, argued Keith Richman, a former Republican state lawmaker and critic of the state's public pension funds. Politicians are encouraged to make promises and are gone by the time promises come due.
  • The state guarantees state pensions and elected officials hold many board seats, a potentially dangerous mix. Wall Street banks waited to find out if they were too big to fail but California has a legal obligation to rescue Calpers if it founders.
  • In any instance where you know you have a (safety) net, your behavior is likely to be riskier. The net here is taxpayer dollars, said Jessica Levinson, director of political reform at the Center for Governmental Studies in Los Angeles.
  • There's no downside to losing money, said Orange County Supervisor John Moorlach, who was a board member of the county employees' fund from 1995 to 2006. (scary quote of the day)

Again, let's reinforce how we fix things in America ... change the accounting! Presto magic.

  • Meanwhile the board is 'smoothing' recent returns, an accounting device which lets the fund take the 2008 hit over many years rather than at once.

So as I've been saying through 2007 and 2008 as well as this year... we've really only just begun the fun. Our system is broken, as our representatives know nothing but to give, give, give and let someone else pay. Most of these folks appear to have only 2 goals in life - (1) re-election and (2) employment at far higher pay at firms / industries they helped during their time in public office. Multiply that ethos over a few decades, extrapolate at the state and federal level, mix in a happy to provide Federal Reserve, and you have prosperity.

Unfortunately, the enjoyment stage is over for the private sector (the public sector gets to keep playing I suppose for a few more decades) ... and the let someone else pay stage comes like a freight train towards us. But as we can see now, instead of actually paying for the sins of the system, it appears we will choose to turn our currency into mush to pay debts in devalued US dollars. Much easier to dupe the peasantry this way.