61% Underfunded Illinois Teachers Pension Fund Goes For Broke, Becomes Next AIG-In-Waiting By Selling Billions In CDS

Tyler Durden's picture

“If you were to have faxed me this balance sheet and asked me to guess who it belonged to, I would have guessed, Citadel, Magnetar or even a proprietary trading desk at a bank.” So begins a story by Alexandra Harris of the Medill Journalism school at Northwestern, which, however, does not focus on some exotic product-specialized hedge fund, or some discount window (taxpayer capital) backed prop desk (hedge fund) at a TBTF bank, but instead at the 61% underfunded, $33.7 billion Illinois Teachers Retirement System (TRS), which just happened to lose $4.4 billion in 2009 (a year when, courtesy of America's conversion from capitalism to socialism, the market rose 60%), and 5% in2008. Yet underperformance can be explained. What can not, is that the TRS has now become a shadow AIG. As Harris notes "TRS is largely on the risky side of the contracts, selling and writing OTC derivatives, including credit default swaps, insurance-like contracts that guarantee payment in the event of a default, that were blamed in part for the 2008 collapse of Lehman Bros. and bailout of insurance giant American International Group Inc., or AIG." Demonstrating just how far the fund is willing to go in the "for broke" category, knowing full well that if it repeats AIG's implosion, the government will likely bail it out, is the disclosure that a stunning 81.5% of the fund's investments are considered risky - this means it is the fourth-riskiest investment portfolio for a pension fund in the U.S! All it will take is another Flash Crash-like event, or a liquidity crunch, and the 355,000 "full-time, part-time and substitute public school teachers and administrators working outside the city of Chicago" will likely end up with a big, fat donut in their retirement portfolios courtesy of some deranged lunatic, portfolio manager, situated externally at a bank like Goldman Sachs, who in taking a page straight out of Obama's bailout nation, has decided there is no such thing as risk. And to those naive enough to think the TRS is the only such fund which has now gone all-in on "no risk and infinite return", wait until such stories start emerging about every single massively underfunded pension and fully insolvent fund in the US.

From Harris' report:

Frank Partnoy, a law and finance professor at the University of San Diego who worked on Wall Street as a derivatives structurer in the mid-1990s, said TRS’s portfolio is an indication that investing is not about what is smart but what will generate the highest returns.

“It’s an epic illustration of how we’ve really gotten lost in financial complexities,” he said, after studying the Illinois Auditor General's 2009 audit of TRS and the fund's March 31 derivatives positions.

TRS said it uses over-the-counter, or privately negotiated, derivatives to maximize the performance of its portfolio and only allows money managers to invest in derivatives if they “have the appropriate expertise and knowledge and employ sophisticated risk management systems,” said David Urbanek, public information officer, in an e-mail.

The fact that TRS trustees and investment advisors approved the use of OTC derivatives isn’t, in itself, alarming. The financial instruments are not explicitly prohibited in the Illinois pension code, and many derivatives contracts provide protection against losses on other investments.

In the balance sheet provided to Medill News Service, TRS’s OTC derivatives portfolio showed that in addition to writing CDSs, the pension fund was selling swaptions and shorting international-based interest rate swaps. For each contract written or sold, TRS received a premium.


And as always happens when one collects pennies before a rollercoaster, the spectacular blow up always eventually catches up with you:

Unfortunately for TRS, its OTC positions soured in late April when Greece’s debt woes worsened, Standard & Poor’s downgraded Spain’s debt to AA and the euro dropped to its lowest levels since the currency’s inception. The International Monetary Fund and European Central Bank orchestrated a $1 trillion bailout to ensure that Greece and the other PIIGS—Portugal, Ireland, Italy and Spain—would not default on their debts.

“As the European debt crisis worsens, TRS’ positions are going to bleed money,” the trader said.

Where it gets even scarier, is that TRS may be fraudulently misrepresenting its massively underwater portfolio:

But the Illinois Teachers’ Retirement System said if it unwound the OTC trades held in its pension fund today, the positions would have a market value of $5 million and a notional value of $1.1 billion. Notional value is the total value of a leveraged financial instrument’s assets.

It isn’t clear how TRS is valuing its OTC derivatives and market experts, among them Rosenthal, who estimated a loss of $515 million as of March 31, were skeptical the OTC positions could have been showing a net positive notional value.

TRS projects it will have logged a $158 million gain from its derivatives portfolio by the June 30 end of fiscal 2010— with $5 million derived from its swaptions, CDS and interest rate swaps positions—and just a fraction of its projected $627 million total return.

A significant portion of TRS’s OTC derivatives are linked to interest rate swaps and those are tied to either the London Interbank Offering Rate or Euro Interbank Offering Rate. Interest rate swaps stipulate for every basis point tick upward in the LIBOR or EURIBOR, the fund is forced to pay out an interest rate that is two basis points higher. This is why the notional value of TRS’s U.S. dollar- and international-based interest rate swaps were in the red by $361.4 million at the end of March.

TRS’ portfolio also includes a large number of swaptions—or the right at a future time to enter into a swap position—which showed a loss of $14 million as of March 31. In addition, the fund sold approximately $154 million worth of CDSs guaranteeing the debt of dozens of companies, countries and states, among them American International Group Inc., GMAC, Panama, Mexico and California. (See graphic).

A large part of TRS’s international-based interest rate swaps positions are linked to the Brazilian Interbank Deposit Rate and Euribor in a bet that inflation would stay low in Europe but rise in emerging markets.

Rosenthal, who said TRS appears to be betting that long-term Treasury yields will greatly increase, is incredulous that the fund even has this view. “Their job is not to play the [Treasury] yield curve,” Rosenthal said. “It’s not their job to have that view.”

Swaptions, Euribor exposure, curve trades? What the hell happened to buy and hold. Does TRS really expect to survive this, when there are sharks like Goldman who know every single trade the TRS has on, and one day, sooner rather than later, will destroy it, but not before margin calling it to death in the process.

The logical question of who the hell is supervising this slow motion train crash surprisingly has no answer:

Section 1-109.1. of the Illinois Pension Code states it is the duty of the board of trustees of a retirement system or pension fund to appoint fiduciaries to manage its assets—including the power to acquire and dispose of any assets—as well as assign others as fiduciaries to oversee activities other than asset management.

TRS said it makes day-to-day operational decisions concerning strategic asset allocation, portfolio structure and manager selection, but cedes all of its investment decisions, within TRS parameters, to professional money managers, a list some 60 names long that includes Goldman Sachs Asset Management, JPMorgan Investment Management, Northern Trust Co. and State Street Global Advisors.

When asked which managers were responsible for the pension fund’s derivatives portfolio, Urbanek, the Illinois TRS spokesman, said OTC derivatives positions are scattered across each asset class because they are “complementary positions” within each portfolio.

According to its investment policy, TRS encourages diversification of assets and “prudent” risk taking because these strategies align with its long-term investing goals. “Increasing risk is rewarded with compensating returns over time.”

“They’re not maintaining effective internal controls,” Partnoy said. “Is it prudent risk-taking to write CDSs on Brazil?”

At the end of the day, it appears the fund is doing nothing illegal by essentially offloading front-office duties to Goldman, which of course is happily trading in advance of the fund, to whose books it likely has full exposure, to benefit its own prop trading desk, and reward its own shareholders first and foremost: 63 out of 63 profitable trading days anyone?

The bottom line, experts say, is that there is no language in the Illinois pension code that prohibits pension funds and retirement systems from buying or selling OTC derivatives as an investment method. In the event of catastrophic losses, lawsuits would be filed against the fiduciaries, but ultimately taxpayers would be left holding the bag. 

And here we see where the next layer of catastrophic systemic collapse will come from: the multi-trillion pension system, which is now invested in the riskiest imaginable products, and whose existence is contingent on a market and economy, both priced to perfection. The Fed is surely aware of this, and will do everything in its power to prevent a catastrophic collapse. Yet the Fed always loses the battle at the end of the day. And if Americans were angry the last time they had to bail out bankers, just wait until it becomes obvious that these very banks blew up the pensions of tens of millions of Americans only so that the very same banks could enjoy at least one more year of record bonuses. It is not obvious where the next crash will happen. And it is certain that nothing will be done, as facing the problem would mean recognizing the massive losses already facing the pension system. And that would be the dominoes that forces yet another round of inevitable mark-to-market, and bank implosions. The timebomb is now ticking and there are merely seconds left before it goes off. We have been warned, and will do nothing to stop it.

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binky's picture

Cut the red wire.  

stickyfingers's picture

"have the appropriate expertise and knowledge and employ sophisticated risk management systems,” said David Urbanek, public information officer, in an e-mail.

Don't we all have that?

P.S. Thank a teacher if you can read this.


JohnKing's picture

Should be renamed to Illinois Teachers Patsy Fund. Where is the State Attorney General?

Edmon Plume's picture

All that would do is ensure the taxpayer is on the hook for the bailout more quickly.  Please no more!

Although, BB can print that amount of money in a flash; so maybe there is nothing to worry about after all.

Translational Lift's picture

"Where is the State Attorney General?"  He's in the hot tub with all the other aholes.  Not to worry, when the Illinois Teachers Fund goes belly-up the Crook-in-Chief will have his Chi-Town boyz make them whole....

StychoKiller's picture

How so?  By handing them a fresh stack of FRNs?!

brown_hornet's picture

State AG is a she.  And her father is the most powerful man in Illinois legislature.

MayIMommaDogFace2theBananaPatch's picture

Another remarkably talented family...

AR15AU's picture

This is what used to be known as fraud.

I guess in a fiat money system its just considered fun and games, like playing something from Parker Brothers. 

DosZap's picture


"I guess in a fiat money system its just considered fun and games, like playing something from Parker Brothers."

It is when your USING other folks money..............these funds are not underfunded because of a lack of employee payroll deductions...............this is what will not be LET go. 

downwiththebanks's picture

The money is being looted from the teachers, fire-fighters, librarians, and other public-sector workers.

And given to the banks, by the government, under the auspices of 'austerity'.

Same story, different suckers.

Edmon Plume's picture

Errrr, the public sector is the government.  It's the private sector that is getting looted.

downwiththebanks's picture

Did you read the article?

Private sector workers have squat for savings, already.  McDonalds don't have much of a pension program.  Uncle Sam's little consumer economy is a hollowed-out shell.  The masses are in hock to their eyeballs because wages have been stagnant for 40 years.  

This piece deals with the contractually agreed upon money owed to public sector workers, by the government, that HAS ALREADY BEEN STOLEN.  

Now it's a matter of the thieves (i.e., banks) and those who enable the thieves (i.e., government) giving the masses a long, slowly-extended middle finger in lieu of payment.

-Michelle-'s picture

"McDonalds don't have much of a pension program."


"To stanch the bleeding of valuable talent, McDonald's in 2004 began offering a rich retirement savings perk. Employees who put 5 percent of their salary in the company 401(k) receive a company match of as much as 11 percent, turbocharging their savings right off the bat. To make sure employees take advantage of the program, McDonald's has made enrollment automatic. And to ease the pain of automatically deferring 1 percent of pay, the company gave managers a one-time, 1 percent salary increase."

QQQBall's picture

And to ease the pain of automatically deferring 1 percent of pay, the company gave managers a one-time, 1 percent salary increase."


Who knew?

downwiththebanks's picture

While I'm sure the workers appreciated the 1% pay cut, one would really have to look at how much these workers have 'gained' from this 'rich' plan to issue it as some sort of proof, right?

How much disposable income should someone making $8/hr. have to invest in synthetic CDOs and long-term T-bills?

Al Gorerhythm's picture

Another head of the Hydra-Ponzi. Watch the purchasing power of your savings depriciate over time as you place your labor-linked credits into the hands of the grinding machine. Your yeild in interest can't keep up with the exponential creation. It is a simple gaming algorerhythmic outcome. You can't fight the maths.

Edmon Plume's picture

Did you read it?  "...but ultimately taxpayers would be left holding the bag. "  I don't know about you, but to me that sounds an awful lot like taxpayers will be left holding the bag.  But wait... it gets better!

When government workers are paid, they get taxpayer - private sector - dollars, ergo 0% real GDP growth, and a hit on the opportunity cost of the private sector.  This often comes at the bargain price of 3 to 10 times what the actual "service" costs, and about 100x what it's worth.  Then they take part of that money and invest it into the public and private sectors, and even internationally.  The pension tanks, and taxpayers are then on the hook for bailing them out.

Let me help you here:  "...the government,..." is paid for by taxpayers, notwithstanding the fact that it has borrowing powers and printing powers that still come back to hurt the private sector in real terms: payback of debt down to multiple generations, and inflation, respectively.

The masses are not in hock due to wages being stagnant, at least not entirely.  They are in hock because they overconsume.  Just like the government - it is the only "sector" growing right now, even as everything else falls off.  Inflation has eaten into the value of the dollar in a big way.

Rest assured, they will be paid in full, but unfortunately it won't happen until inflation makes us all trillionaires, at which point a tenth of a federal bank note will pay off most of their pension.

There's theft all right.

downwiththebanks's picture

I'm not worried about what MIGHT happen.  I focus on what has happened.  The banks have stolen a bunch of money owed to the workers, with the government facilitating the theft because they're owned by the banks.

The rest, how 'unproductive' workers are and such, is just window dressing meant to cover-up the crime.

JLee2027's picture

What money owed to the workers?  What are you talking about? They made bad loans and invented financial tools that self-destruct after they make billions, thus requiring bailouts.

You sound like a commie.

AR15AU's picture

True that. I guess I just believe that if the money were in the form of gold coin, there would be a lot more scrutiny on where it was going. With paper / electronic money, seems all too easy to just move it into derivatives and other electronic crap without much cause for alarm. If you moved a hoard of gold into something synthetic, pensioners might be like "what did you do with all of the gold" a lot sooner... 

Al Gorerhythm's picture

Yup. It (gold) would make it a lot more difficult for the bureaucrats (and banker facilitator/owners) to paper over their inevitable sins. Pick one.

SignsAndWonders's picture

Who should I contact about getting some synthetic exposure to this mess?  

Internet Tough Guy's picture

You get exposure through your tax bill. No upside for you, though.

EscapeKey's picture

Look, can Bernanke just start the printing presses already? We all know it'll happen at some point, anyway.

RichardENixon's picture

They're already on. Have been for a while now.

MayIMommaDogFace2theBananaPatch's picture

If you're really quiet you can actually hear the presses churning away. 

And when they briefly stop the presses to put up a fresh roll of paper -- you can even hear the OHs and ONEs dropping into the electronic-bit-bucket like so much hail...

Thisson's picture

This is good news because when these things finally blow up, those of us who were prudent and saved capital wisely will be able to demand great returns when we are asked to recapitalize the insolvent.


One can only hope that the incompetence accellerates so the inevitable blow-up comes sooner, hastening the days of our lucre.

Internet Tough Guy's picture

Asked? Did anyone ask you what rate of return you wanted to recapitalize the Squid? They will take your money at IRS-point.

-Michelle-'s picture

You're assuming we'll be asked.

SteveNYC's picture

I'm with you on that. I think I'll set a low benchmark, oh, say 20%, first lien, fully secured lending, with payments weekly.

This is a complete fucking joke, pension funds gambling, speculating wildly with supposed "pension" cash. No more bailouts, not this time, not ever.

Ben "Moral Hazard" Bernanke is going to feel the wrath of "unintended consequences". I just hope they rope that fucker Alan "The Put" Greenspan and all the other co-conspirators back in for one big jail-fest when it all goes down.

darkpool2's picture

LOL.....not saying I disapprove of your financial rectitutude, but seriously, you expect to get some fat return later on for `bailing these sesspools out.  Your funny money wont buy much at that time, even if it is making 1000% pa !!!




WorldBeta's picture

They expect an 8.5% return.  Discount at T-bonds/bills and they are 80%+ UNDERfunded, ie broke.

Gordon Freeman's picture

They be fuckin' broke, alright...

Cursive's picture

LOL.  Evel Knieval was closer at Snake Canyon then these guys are to being funded.

Fred Hayek's picture

And he had a smoother landing that time in London with the buses than all the rest of us will have.

SimpleSimon's picture

Ooops. Obama needs to raise that $50 billion another-stimulus request to cover for his home state.

Yikes's picture

All I feel is rage.

Internet Tough Guy's picture

You are jack's sense of impotent fury.

New_Meat's picture

g? I think you mis-typed for "p" - Ned

Caviar Emptor's picture

Pensions, municipalities and large state budgets: the blackest holes in the economy right now. The question is: will THEY be, somehow, NOT too big to fail? 

Mu guess is that the Administration, in consultation with Wall Street bosses, will not have the zeal to bail them out that they did for the banks in 2008-9. Yep, teachers, cops, firemen and hospital workers will be hung out to dry. My guess is they'll have to accept huge "adjustments" that will come in steps like empty promises: increased barriers and requirements, decreased compensation. 

Of course the cuts in services are coming. Big ones. Jails will have to disgorge some prisoners (they'll keep it quiet), law enforcement will get downsized, garbage will sit a bit longer, courts will have fewer workers and judges will be culled. And hospitals. They're already closing them at a fast pace in states like NY. Look for that to continue as well as fewer nurses, technicians and maintenance. 


downwiththebanks's picture

Exactly right:

It's called theft.  Theft, by the corporations, of the people, using the biggest weapon capital has:  the law.

Same as it ever was.

Cursive's picture

You wanna see some pissed off people?  Get the members of AFT and NEA mad.  This is a hornet's nest. If this goes down in Illinois, every teacher in the country is going to know about.  There will be violence.

Jean Valjean's picture

I'm with you on this.  Teachers, in general, believe their own bs more than any other profession.  Blankfein saying he's doing "God's work" pales in comparison with a teacher's feeling of self importance.

downwiththebanks's picture

Teachers teach.  Firefighters fight fires. 

And Blankfein rapes your mother.

That you equate them to one another says much more about you than them, Jean.

You should really change your pseudonym.

Jean Valjean's picture

I didn't equate them.  I used them as a comparison in an attitude of self-importance which I will stand by "in general".  Perhaps you are a good and humble teacher or perhaps you are a teacher who rapes childrens minds.  I can't tell.

At least I didn't compare the gulf oil spill with 9-11.  Now that would have been asinine.