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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downwiththebanks's picture

Your education system does exactly what it's supposed to do:  create good, disciplined, obedient capitalist workers.

And criminals, and drug users, and soldiers . . . because that's where the profit is.

Jean Valjean's picture

Thanks, I can tell which kind of teacher you are now.

Cursive's picture

@Jean Valjean,

Well, earlier in this thread someone posted something to the effect that if you can read this, then you can thank a teacher.  Really?  When did teachers become the sole keepers of learning and wisdom?  How the hell did our Founding Fathers know anything before the Dept. of Education was created; before the teacher's unions were established?  Go on campus and spend some time with the Education majors.  Scary.  Very, very scary.   But not half a scary as the Education establishment.

downwiththebanks's picture

... and then, when you're done, take a run around a Wall St. firm . . . doesn't even matter who:  Is it possible to encounter a higher volume of overprivileged, ignorant bigots anywhere on earth?

Jean Valjean's picture

Volume, no, you're right.  Percentage?  Yes, a local school board meeting.

MayIMommaDogFace2theBananaPatch's picture

A fine observation.  A very-fine observation.  (re: volume)

Cursive's picture


Totally with you.  I want the send the banksters up river too.  Check out the link:


puckles's picture

Yes, practically anywhere in DC.

Apostate's picture

Hahahha, actually, Wall Street is stuffed to the gills with people who believe earnestly in the mission of the Department of Education. They gave you your brilliant president. And they market the bonds that keep you in crack cocaine. 

Wall Street is the only thing that keeps this piece of shit government afloat. It's a symbiotic relationship. 

-Michelle-'s picture

I started out as an education major.  When I realized the professors actually believed the swill they were teaching, I withdrew.

We're homeschooling.

uraniuman's picture

I concur - 90% of them lean to the left - no sympathy here for those who would pollute young minds with socialist garbage.

Renfield's picture


I wasted years in public so-called 'school'. Thank God for my parents' dedication to learning/education in its true sense. (Alas, not about finance though.) My parents were the best teachers I ever saw. I feel real sorrow for those many many children whose parents choose to trust (or of economic necessity or mental inability, must trust) schoolteachers.

Miss Cleo's crystal ball tells me:

a) Your kids might not be very grateful now or for awhile.

b) When they grow up they will bless you for your dedication to their future.

I hope more parents will follow your good example and if not homeschool, at least ensure that THEY are their kids' primary teachers.

WaterWings's picture


Good for you. It's the way to go.

DoChenRollingBearing's picture

When I took Linear Algebra (sophomore level math after a year of Caculus), Education majors who wanted to teach math had to take that class.

They were the slowest students... 

OK Linear Algebra is abstract and hard, but it is perfectly OK for the state to require competency in that before unleashing future math teachers into the world.

I can only imagine Education majors who do NOT want to be math teachers...

Edmon Plume's picture

They have "math for [insert name of non-science major here] majors" courses, that miraculously satisfy the math requirement.  May as well not require anything at all.  I've never seen a less rigorous curriculum with more fluffy bunny requirements than education and other liberal arts rubbish.

On the other hand, there are some excellent and bright teachers out there, but they tend to lose their appetite for teaching when they realize it's a lot of silly CYA paperwork, and they have to deal with irate parents who are upset that their precious do-no-wrong kiddo is being poorly raised by a teacher.

Therefore, I don't think it's all a problem with dumb teachers (though I've seen my share of them), I just think that the word is out that the intelligent need not apply lest they be bored forever, and be spending a lot of time raising kids instead of teaching them the three R's (which they don't seem to do anymore).

velobabe's picture

i am a pretty good example of incompetent educators.

i received a colorado professional K-12 with an endorsement in art.

skirted around, n e v e r  had to take one math class.

gotta love it†

DoChenRollingBearing's picture

velo, I meant that future teachers of MATH had to take Linear Algebra.

And THOSE Ed majors were the slow ones.

Al Gorerhythm's picture

Good call on your self assessment, vb (having winced at your grammatical errors in your posts). 

Your mistakes are usually when you use contractions, or by miss-use of homonyms, such as: there for their or they're; your for you're; then for than; a lack of capitals when using proper nouns or at the start of sentences.

It is little wonder that (a) there, (b) their, (c) they're  (circle the correct answer) are problems with the teachers fund, when you consider that maths teachers teach their, there, they're (ditto) charges, that compounding interest payments, when calculated annually, add "value" to a savings account as they accrue.

The head of the maths department (whom I raised this (value) issue with), of a well respected school, wasn't aware of the declining purchasing power of each dollar, as the nominal figure (supply) grew. He believed that we were all getting richer!

He was well aware of supply and demand theory and how prices fluctuated as supply varied. However, he couldn't apply the same formula to the increasing supply of money. He couldn't account for where the new dollars in interest came from, either. He thought they came into existence as GDP grew!

(Un)believable (the mess we are in), no?!  


velobabe's picture

ok rhythm (that was my method), if you have only found 5 - 10 mistakes so far, i don't think you have read all my work.


i am pretty sure i wasn't put on earth for my brains†


Hulk's picture

DCRB, abstract alg is abstract, linear alg is well, linear!

I had my two teenage kids ask their algebra teachers a simple question (due to my suspecting that both these teachers were clueless) as follows:

A brick weighs 10lbs + half a brick.How much does a brick weigh?

Neither teacher could answer the question. Neither teacher should have been teaching algebra, they are ruining kids for life, as far as math is concerned...

John_Coltrane's picture

You mean:  B = 1/2*B + 10 or B=20? (I'm not a teacher)

The real problem in life is that everyone likes a 'free lunch".  Free is always the favored price.  So, pensions set goals of 8.5% returns so that their pensioners don't have to contribute the appropiate amount of real present earnings or save for their future expenses when they retire.  Thus, they turn to gambling vs saving.  Might as well buy lottery tickets which I've always considered a great way to  tax stupidity without having to administer a test. 

Hulk's picture

Thats it, it is that simple...

WaterWings's picture

Free is always the favored price.

Which is why I can't understand Katie Couric.

New_Meat's picture

matrix requires calc???--gotta be a pretty skosh calc thang, like a year to get over the idea of "slope" and "area under the curve"?

- Ned

DoChenRollingBearing's picture

Hi Ned, and hi to you too big guy Hulk!

Ned, my class was more than matrices.  Calculus 102 (whatever) was prereqisite because we did things like Inner Product Spaces, Orthonormal Sets and other very ugly things that required knowledge of integration.

Hulk!  Good to see you again.  LOL your kids asking the algebra teacher a question that s/he should have been able to solve "by inspection" (not having to actually do the algebra).  I don't know if that really is funny though...  Never made it to Abstract Algebra, although I did inspect the textbook...  I would not have survived Abstract Algebra.  I used the term "abstarct" above because Linear Algebra is more abstract than Calculus ever was for me.

Kali's picture

My great grandmother taught me to read at 2 (Dr Seuss).  I knew basic math by the time I entered kindie garten. Grew up reading my mother and father's med books.  I was so bored in school it was disgusting.  I got in trouble in English class in high school cuz I was so bored with prepositions I was reading Steppenwolf.  Not paying attention you see.

velobabe's picture

ditto:    I got in trouble in English class in high school.

sounds like you got all the fairy brain dust, no fair.

man i had a blast, cheerleader here†

Kali's picture

NO, I was lucky enough to have relatives who cared about my education, I don't think Im more "naturally" intelligent or gifted than anyone else.  School has nothing to do with that, even back in the stone ages when I went.  : ) 

PS- us American kids in the family were considered the dummies.  My cousins in SA knew 3 languages and college level mathmatics (by US standards) by the time they graduated HS.

New_Meat's picture

Kali, I've been reading your posts.  I used to do honest work as a control engineer, now off with other ventures.  Tougher to build business to find work for the kids and all of us.  I'm responding to the "dummies" comment.  Not my experience at all--US kids are almost good, except for my bad (and long-term) experience with bringing Ivy-League "engineers" into the real world.

- Ned

velobabe's picture


f e m a l e s     a r e    t a k i n g



Geoff-UK's picture

If you can read this, thank a teacher by bailing out her pension fund via your tax payment.

Cursive's picture

Maybe it's that I've had an evening drink, but I did laugh out loud when I read that.  Just for giggles, what percentage of U.S. education majors would know to pronounce "Geoff" as "Jeff" and "gaol" as "jail"?

StychoKiller's picture

"If Congress can employ money indefinitely to the general welfare, and are
the sole and supreme judges of the general welfare, they may take the care of
religion into their own hands; they may appoint teachers in every State, county
and parish and pay them out of their public treasury; they may take into their
own hands
the education of children, establishing in like manner schools throughout
the Union;
they may assume the provision of the poor; they may undertake the
regulation of all roads other than post-roads; in short, every thing, from the
highest object of state legislation down to the most minute object of police,
would be thrown under the power of Congress... Were the power of Congress to be
established in the latitude contended for, it would subvert the very foundations,
and transmute the very nature of the limited Government established by the
people of America." - James Madison


We were warned.  Somehow, the stupid/greedy were placed in positions of Power.  Mistakes were made, etc.

hedgeless_horseman's picture

You see the problem.  Can you predict the solution?

stickyfingers's picture


Sorry, that was sarcasm. I thought on ZH I wouldn't have to be obvious.

BumpSkool's picture

... I know which one will kill more people ... 

Fred Hayek's picture


And the flip side of it is that they're simultaneously the most focused on their compensation. 

downwiththebanks's picture

As 'focused' as baby rapers like Blankfein?

Fred Hayek's picture

Ah, an exception to every rule.

downwiththebanks's picture

Yeah - he's unique on Wall St.  Sure.

John_Coltrane's picture

Hey, Blankfein is a hard nosed trader who grew up in the slums.  He never pretended to be anything else.  Trading is all about taking other people's capital-its a zero sum game. 

DosZap's picture


This is in Illinois.

NO WAY the Bamster allows this to go down,no way.

He's already blaming the GOP for Dr's Medicare shortfalls.

Sometimes, I cannot believe how stupid the sheeple are, I mean come on.

Cursive's picture

Bwhahaha!  I remember people (like Leo the solar equity pimp) telling me no way the June NFP report wasn't going to singe the hair off my gonads because Obama wouldn't let that happen.  You can fool all of the people some of the time and some of the people all othe time, but you can't fool all of the people all of the time.  And again, teachers are some badass muther######s.  This will be frightening to watch.  You are going to see people who never worried about "the Market" realize that they have no retirement funds.  Hell hath no fury like a sheeple scorned.

New_Meat's picture

fool all of the people ... Lincoln

Mr Lennon Hendrix's picture

Asking for pensions and health care is about to be self serving.  When the SHTF, crum snatchers they will be.  We will not have justice until we free ourselves from the monie itself.  This is why the Tea Party is stalling (Sarah Palin?).  People's interests seem self serving; they may not be, but they appear to be.  I agree we do not want more taxes, but why do we not want more taxes....Not because we need more money, but because the tax system is unconstitutional in the first place.  Do Tea Partyers want to end the Federal Income tax?  Do they know why?  I understand some do, but is that what the party is based on?  Is their mandate-'End the Fed because the Federal Income Tax is unconstitutional?'  I think not; at least, that is not what is getting across.  What is getting across is 'I want what is mine'.  And that is fair!  But life is not fair.  Not until we make it fair.  And the way we make it fair is by instituting a sound monie policy.

The party should be based on the fact that the IRS and Fed are running an illegal and unconstitutional racket.  If the Tea Party used this as their guillotine, you would see change.  Unfortunately the Tea Party appears to be self serving; they appear to want money, or not have to give more of their monie to the government.  But it is that monie that is unconstitutional in the first place.  Thats like deserving a unicorn.  I will say again, I know it is not this way for many of its members, many do understand that the system is a false paradgm, I am merely analyzing the organization's manifesto, as I do not hear the members speaking truth to power  righteously at this level.  End the Fed, yes.  But no new taxes?  NO FEDERAL TAXES PERIOD!  Let me put it this way:  The feelings you are having is that the system doesn't work because it never worked.  We need a new system, plain and simple.

DoChenRollingBearing's picture

I'm with you all the way Mr Lennon re Federal Income Taxes.  For many reasons, privacy, unconstitutional, others.

Tea Party would get a lot stronger support from the wealthy (maybe not the MEGA-wealthy though) if they push banning the Fed and the IRS.

Ain't gonna happen though.  Not until several million of us get MORE PISSED OFF!

Oh, and don't bailout the Illinois TRS.  They were adult participants in screwing themselves.  Besides, I don't like public sector unions anyway.

Mr Lennon Hendrix's picture

Unfortunately I agree (if there was a need for bailouts, it should have been for the people instead of the banks), no bailouts for nobody. All adults here, except for the Fed- they sit at the kids table and we should treat them as such!

JB's picture

the Tea Party was hijacked almost from its onset...

DosZap's picture


By who?.

You think the GOP?.Evidently you haven't been following the winners in the primaries.

Top GOP front runners,have been getting their ass handed to them.(guess who by?).