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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Geoff-UK's picture

Man do I hate to bear bad news--but the 16th amendment of the U.S. Constutition makes income taxes, de facto, Constitutional.  The 16th is, of course, the second most unfortunate amendment (after the 19th).


Income tax is immoral, but it's definitely Constitutional.

StychoKiller's picture

You should do some research on HOW the 16th Amendment was passed (hint:  Illegally!)

New_Meat's picture

I'm with your Hendrix side, nay Lennon

I agree we do not want more taxes, but why do we not want more taxes....

-- because they are pissing the money away. (in the small picture).  And they are pissing THE MONEY AWAY in the big picture.

Don'tcha know.

So even the Keynesian "justification" is bogus.

- Ned


Thoreau's picture

There will be bailouts

Coming to a theatre near you.

Sudden Debt's picture

Sequels are never as good as the original :)

-Michelle-'s picture

Here comes the "Retirement USA Initiative!" 


And I wondered why Andy Stern left SEIU and was appointed to Obama's National Commission on Fiscal Responsibility and Reform...

DosZap's picture


This is exactly why anyone here, with a brain, has closed out of their 401k's, and will be closing IRA's, if they haven't already....take the tax hit, and invest the rest in PM's........Agri,Commodities.

The US Gv't, and for damned sure SEIU, is not going to get one more dime from MY lifetime savings....anyone stupid enough to not see what's coming, deserves what they get..........NOTHING.


DoChenRollingBearing's picture

Closed mine in 2008, paid the tax and penalties, but now the money is mine.

Some of that money is nice and safe invested in gold.

+ 100 DosZap

Edmon Plume's picture

Closed mine out in 2010 :) except for a couple of small ones that aren't worth the paperwork.

I expect that paying the piper now will be much cheaper than paying the piper when I withdraw it.  By that time, taxes will be much higher than the penalties I'm paying this year, and now I have liquid assets at my disposal.

Kali's picture

Closed mine 2007, PMs baby.

ColonelCooper's picture

Don't know how SEIU works, but I sure as Hell can't TOUCH my money in either my LIUNA or my IUOE pensions.  If I could, the money would be out of there so fast you'd hear a thunderclap and smell ozone.

DosZap's picture

Knew you were a smart cookie...........hehehehehehe

Village Idiot's picture

I thought you said that gold fell off a boat? In deep water.

DoChenRollingBearing's picture

No.  Not yet.  I said to posters who claimed that it happened to themselves (they lost their gold in a boating accident and similar).

What I said is that I will have to be VERY CAREFUL next time I take my gold and guns out boating with me.  Very Careful!

Caviar Emptor's picture

Here here. 401k's will become widowmakers as the rules for redemption get tougher, the tax liability increases and the investment opportunities narrow. Also beware defaulting plans once the redemption avalanche starts. There's more than a passing chance that the government will impose a redemption freeze if too many people close out accounts. Good luck after that. 

DoChenRollingBearing's picture

+ 100   ^-- Edmon and Caviar.

When I closed my IRA, I did not even think that taxes would be going up.

This is the year.  Maybe we (all of you actually) can bring the system down by selling out the 401(k)s and IRAs.  That would be supreme irony, markets crater because people want their pension money...

DosZap's picture


You got it bro.............the window is already half shut, and the Bush tax cuts are gone Jan1st.

If you have a half brain, get it while you can..........and MOVE it into something tangible.

Hide and watch, the Euro, is going to kick the shit out of the dollar....News of it's death, has been greatly exagerated...............dollar's,need to be dumped.............

QE to Infinity, is here, until, there are NO MORE suck, er' buyers.......next 5-1 Trillion bailout, will be it.................33 states are DOA now, they just don't know it.


ZackAttack's picture

Everyone be sure to bookmark this link when Illinois comes calling for the Feds to bail them out. 

Not going to happen.

Chemba's picture

This is no big deal.  When it blows up, the Socialist Obama will simply provide a rescue so as to "save the pensions of hard working Illinois teachers", bringing the liabilities onto the Federal ledger.  Covering those liabilities is no problem as Banana Ben can simply type [$100,000,000,000] [Enter] one more time.  Not a problem, guys.

Magua's picture

Exactly - they are gamblin with house money. There are two words you need to know, "Chicago" and "teachers", which let's you know O will bail them out in a heartbeat. Dig deep taxpayers..

IBelieveInMagic's picture

What taxpayer? Over 50% pay no taxes and the rest, negligible amounts. No one is asked to pay for this -- as long as the rest of the world continues to accept USD in exchange for real stuff, we can get away with it... Enjoy till then! Free lunch defined...

DoChenRollingBearing's picture

That's yet another problem with the Income Tax.  Once less than 50% have to pay, hey why not raise taxes on the rich?  No problemo!

Free lunch indeed.

Maybe I should go 50% into gold and have most of the rest of my money OUTSIDE the USA.

DosZap's picture


Sounds like a plan,(one I have been contemplating) except, out of here, and into what?.

We have had the good fortune to get this rally in the USD Index, it's not going to last much longer..........

Can't be paper,(anyones) all of it is going to be butt wipe, ALL.


tizzleofdoom's picture

that is a lot of zeros. 

Implicit simplicit's picture

Freddie and fannie for RE nationalised debt with SallieMae soon to join the dysfunctional  debt family for school loans and  teachers' pensions.

downwiththebanks's picture

BS:  Obama is a socialist when it comes to giving money to failed capitalists and zombie banks.

To the people - the garbage collectors and bus drivers - Barry Sotoero offers only his middle finger.

That's why he's a capitalist.

faustian bargain's picture

incorrect. stop redefining capitalism to suit your ideology. you're looking for lots of 'junks'.

downwiththebanks's picture

You're the one reducing capitalism to make-believe.

I care about how money is 'made', how power is attained, how stuff is produced.  And, importantly, who accumulates it.

That's what makes capitalism capitalism.

faustian bargain's picture

The use of force and fraud are not part of capitalism. An economy that depends on force and fraud to attain its power, produce stuff, and 'make money', is fascist or socialist. But you know this.

You are looking at the history of the US economy and labeling it 'capitalism'. You are doing your own mind a disservice, if you believe this. And to continue to misconstrue capitalism in discussion is an attempt at deception.

Here's a suggestion: just describe what you're critiquing without using the word 'capitalism' and I'm sure you'll get a lot more people agreeing with you. You're not going to lever people into believing that capitalism is the Big Bad just because you're misapplying the word.

Thoreau's picture

"An economy that depends on force and fraud to attain its power, produce stuff, and 'make money', is fascist or socialist."

Right. So America/US has been capitalist-based since... never. Thanks for clarifying the obvious.

faustian bargain's picture

One would think it would be obvious, eh.

puckles's picture

Incorrect.  Washington's Farewell Address specifically counseled against any immoral activity, specifically with respect to international commerce and international relations in general.  It is a classic isolationist piece, and appeals to the common sense of the people to avoid foreign entanglements, essentially, because that might ruin their free competition, by obligating the State to assist other nations in direct contravention of the State's own natural interests.  This classical liberal philosophy in no way recommends either force or fraud--indeed, quite the opposite.  America was supposed to be the enlightened City on a Hill, the Columbian beacon to the rest of the sullied world...How far we have fallen from that ideal of exceptionalism...

hedgeless_horseman's picture

Exceptionalism is so unfair, undemocratic. 


downwiththebanks's picture

You call 'misapplication' the examination of "capital" in the real world.  That's fine.  But I know, and so do you, that "Capital" is the engine that drives our society.  Understanding how it drives, rather than pretending it doesn't, seems sort of important. 

So you can hypothesize about utopias all you want:  I'll stick to looking at how Potosi came to be or how Liverpool was built.

faustian bargain's picture

The engine that currently drives our society is credit, not capital. And the only reason that has happened is fraud on a massive scale.

downwiththebanks's picture

The credit doesn't exist for its own sake.  The credit - i.e., debt - is required to keep buying the tanks and cocaine, sneakers with lights in them, and iPads.  

It exists to buy crap vomited out by an economy that has overproduced itself to stagnation.

Furthermore, the iPad bought with a credit card still requires coltan, no matter how its bought.  And getting coltan requires the murder and rape of Congolese peasants.

Circumspice's picture

So do computers. You're using one. Sure, it's probably not Congolese coltan, but hell, by buying one you're contributing to international demand in the same way. Is this a smear of your ideology? Does it, in fact, smear all non-Luddite ideologies, as they all demand computers and mined products, generally?

Insert witty title's picture

Incorrect, production drives the economy. Capital is surplus production that originates in what you might know as savings. Savings can take the form of wheat in a barn, or gold coins, or fiat currency, but its easier to loan out as some form of money. The people who generate surplus productivity take a risk when they give it to someone else, they are compensated for this risk via interest. Interest, or the price of capital also regulates its use through time as the supply of excess production ebbs and flows, and the demand for capital ebbs and flows.


So to try and educate you a little bit, although i don't have nearly the patience with you as faustian has, production drives the economy. Not capital.


I recommend you read Say, then get stuck into the Austrian school. Even if you are philosophically oppossed you have a responsibility to learn the other side of the argument.

kingwallop's picture

Real Capitalism was over the minute the Central Bank went in.

downwiththebanks's picture

So the days of chattel slavery were idyllic?

kingwallop's picture

What does that have to do with anything? You prefer the economic slavery of today? Every world power has had, and still have slaves. 

DosZap's picture



You mean their gone?,,,,,,,,,,,

John_Coltrane's picture

Let me repete this simple notion one more time:  capitalism is private control of the means of  production-nothing more, nothing less.  Why does this work better than any other system?  Simple, it depends on independant participants choosing how to deploy their labor and other capital.  How does every other system work?  Central planning by "experts".  But there are no real "experts" only those who seek power and control over others.  In these totalitarian systems the end justifies the means, which is state coercion.  For a libertarian capitalist the means determine the end!  Think hard about this fundamental difference.  In planned societies experts attempt to fix prices and wages via subsidies, tax breaks etc. but only free markets (independent participanats working in their own self-interest) can determine the "price" of anything from a gallon of milk, to the cost of a medical procedure.  The governments only legitimate role:  enforcement of the rule of law to prevent abuse by the various participants.  If you seek to understand anything please read "the road to serfdom" by F. Hayak so you can make intelligent contributions to this forum. 

Caviar Emptor's picture

Don't you see? Obama and his bosses on Wall Street won't find it in their hearts to bail out teachers or any retirees like they did with the banks in 08-09. Somehow they'll enforce a big haircut and extend redemption times. They'll also change the rules to restrict payments. 

This will be a big prelude to similar restrictions and changes to social security, medicare and other retirement benefits. All private 401Ks and 403Bs will follow suit so they don't go broke.

QQQBall's picture

Da gots to do it for da' kids.  Chemba nailed it - for hardworking teachers who are building a future by teaching our children.



DosZap's picture


I disagree, why?...their Unions.

Caviar Emptor's picture

Cause of the politics. Big money boyz don't wana use money for teachers that they can use for banks

The Merchant of Venice's picture

Illinois taxpayers are the first ones on the hook.  Illinois has an income tax rate that is a flat 3%.  About 25% of pols support raising the rate.  The people overwhelmingly oppose raising it.  The folks know they're paying a lot more than that in excise taxes, property taxes, sales taxes, and fees for everything.

The State has ways to raise funds, but the people are never going to endorse saving a system that will pay almost 1 billion dollars in retirement pension to just 100 educational bureaucrats.  They will demand haircuts.

Careless Whisper's picture

The fact that TRS trustees and investment advisors approved the use of OTC derivatives isn’t, in itself, alarming.

Oh really.


buzzsaw99's picture

Sure, wtf, take your last $30B and put it all on 17 black.