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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Kali's picture

Reminds me of South Park, playing roulette to "buy" the town back from the Indian Casino.  They win, then couldn't resist the double down and spin again.  Lost it all.

John_Coltrane's picture

Well at least we know the probability of failure of that is 37/38, while selling CDS on say Greek bonds is much less predictable but likely worse odds.

Mr Lennon Hendrix's picture

America you are being fleeced!  This right before you are to be put down!  There is no next year!  Buck the system!

DoChenRollingBearing's picture

I hear you again Mr Lennon.  I am working on it as hard as I can.

Nothing to invest in the way I see it.  Who wants to open a business now?

dark pools of soros's picture

did anyone tell them they have a better ROI by moving their remaining chips to the craps table?

ZackAttack's picture

They should have Goldman invest their money... Oh, wait...

Bruce Krasting's picture

Don't worry about this at all. Fin Reg will address all of these problems. Everything will be fine. For about another six months......

centerline's picture

Chase the desperate money into the riskiest assets - and club them like baby seals.  Straight-up play.  Shameful, but expected.

Miles Kendig's picture

The flavor of the day continues to gain in acceptance by the ravenous hordes of Gerbervores.  At least until it is all spit back while the kool aid loaded juice cup goes flying.

Mr Lennon Hendrix's picture

I think Damon read John FORBES Kerry's bio.

Mr Creosote's picture

But at least my pension would be guaranteed.

plocequ1's picture

You don't like it, close your 401k, You don't like the way the Stock Market is being manipulated, Get the fuck out of it then. If you know your money is being used as gambling money, Put it in a Liberty Safe and buy a Hawkin Rifle. Hatchett Jack is giving one away.

dumpster's picture

Illinois pension system no problem , just have leo write a puff piece,, it will all come up roses and wine.

just a \blimp in a cycle.

and soon the growing economy will blossom,

if not.. ask for leo.    and ask for your change back,


DoChenRollingBearing's picture

LOL, good seeing your pieces dumpster.

The teachers themselves deserve some of the blame.  Bet they're unionized too.

Actually, Leo probably would have lost LESS money for the teachers with solars rather than the TRS putting it all in derivatives...

Rusty Shorts's picture

"Liberty Safe and buy a Hawkin Rifle. Hatchett Jack is giving one away".

 - hahahaha..and the system is giving your ass away, HAHAHAHAAAA



Nihilarian's picture

Ahnold to Bernanke: "Get to the Choppah!!!"

BoyChristmas's picture

Ho Ho Holy Shit. Accounting on a hold-to-maturity cash flow basis which is entirely predicated on future bailouts. Does E&Y do their accounting?

donethat's picture

"Fiduciary Responsibility?"

The Alarmist's picture

Yeah, I have had these Trustee briefings where the advisors tell you that you will (most likely) not lose anything near the notional value at risk, which is supposed to make you feel like you have been absolved of your guilt.

You would be surprised just how many pension funds around the world have been and continue to write CDS coverage.  Check that ... it should have read "You will be surprised ...."

TooBearish's picture

Wait - Leo is gonna tell you this stategy is AOK causa St Pension funds never expire, they exist in infinitum, and short falls will be made up by tax increases, so to pursue, risky and BTW high margin to the dealer, deals is well within their bounds....PMs say fuk it might as well get good Blackhawk seats and pay GS in full....

RockyRacoon's picture

Simply astounding.  Good money was put up and it was promptly lost.  If the money had gone to the casinos (better odds probably) then someone would be going to jail.  Since it went to the TBTF banks nobody goes to jail.  There is not much difference in either case but one method of going broke is somehow more palatable than the other.  How did that happen?

Renfield's picture


Good eye for the big-picture irony!

hambone's picture

What do you guys expect - look at this from the pensions POV.  Either:

A- admit you are underfunded massively even after the big market recovery and that responsible rates of return will be nowhere near enuf to pay benefits...talk of benefit cuts or raising taxes would both be death to those who admit this.

B- double down and take the 25% odds you win...nobody in public is the wiser if it works out.  If you lose, well, you were gonna lose anyway and the fact you went completely broke vs. partially broke doesn't matter...at least you pushed it out to the next poor sucker in office.

Nobody wins or gets credit for avoiding the crisis.  Politicians only gain importance and stature by putting off the problem til another day ensuring what could be resolved today will ultimately be a crisis "nobody ever saw coming" before we begin to deal w/ it at 100x's the cost.  American politics 101.  Easy choice.

This is the "democracy" our founding fathers feared.

JB's picture

i think i've seen this movie before. Nick Leeson was the central character...

StychoKiller's picture

"I cannot undertake to lay my finger on that article of the Constitution which
granted a right to Congress of expending, on objects of benevolence, the money
of their constituents." - James Madison


But, we've been here before:

"Do not blame Caesar, blame the people of Rome who have so enthusiastically acclaimed and adored him and rejoiced in their loss of freedom and danced in his path and gave him triumphal processions. ... Blame the people who hail him when he speaks in the Forum of the 'new, wonderful good society' which shall now be Rome's, interpreted to mean 'more money, more ease, more security, more living fatly at the expense of the industrious.'" - Roman statesman Marcus Tullius Cicero (106-43 B.C.)

deadparrot's picture

I once had an interview with a manager with one of the smaller state's boards of investment. What a smug idiot. He completely dismissed me when I said I had left my job at a mortgage lender when it became completely obvious that the housing market would soon crash. It's really no wonder that state pension funds are considered the dumbest of the dumb when it comes to institutional investors. I'd really hate to be a state employee knowing this guy was managing my pension.

BumpSkool's picture

True Parrot True ... back in the day, everyone who worked for a brokerage firm was trying to get a Pension Fund as a discretionary account because you could churn them to death, back out the winning trades and essentially fleece them. They were always so dumb they could never figure it out! 

Quinvarius's picture

He who gets canned and moves his retirement into an IRA first wins.

John McCloy's picture

   When will they understand there is entirely too much debt, evaporated capital and more monstrous debt on deck for all the years of frivolous lending, borrowing and previous money printing than there is ink available. Every day they continue to pretend the boogeyman will not come out of the closet so long as they feed him more and more meat to keep him at bay only ensures he is going to be both incredibly larger and hungry the day he emerges because there is no meat left.

And when he gets out not only is he going to eat everyone in their house but he is going to eat everyone in every block on the house.

epobirs's picture

I've tried to explain to people just how extreme this has gotten. There is no upper limit to the amounts that can be symbolized on a printed page or within a DRAM chip but the reality does have limits. Just as you can easily depict a number greater than all of the particles in the universe, you can easily perform transactions on volumes of capital vastly in excess of what can be found in the valuation of virtually everything that can be assigned a value.

Have you ever said, "Not for all the money in the world." Well, the debt of all the nations left that behind a long time ago. We're dealing in such immense sums, above and beyond any real-world value that can be demonstrated, that somebody has to take a massive haircut at some point. Say, down to around the waist. The kind of haircut too many of the victims cannot walk away from because it doesn't just grow back once chopped off.

Freddie Krugerrand's picture

These teachers would be better off giving their money to the Shamwow spokesman and having him invest it.  He's got to be more trustowrthy than Goldman Sachs.

Biff Malibu's picture

I am involved in a small microcosm similar to the TRS.  I am on the Pension Board and a fiduciary for a small public entity, fund value about $18 million.  The board has 5 members, the main 3 members are all retired in there 60's, 70's, and 80's with high school educations at best.  Myself and one other member are mostly patsy's to take the fall if anything goes wrong.  Our "professional" money manager that the board hangs on every word has told us flat out, "well, we haven't been having much luck, we've been buying at the tops and selling at the bottoms, therefore I'd like to switch us to an asset allocation plan..."

Me: "So basically we're switching from active management to passive management???"

Professional: with a somewhat panicked look on his face, "Oh NO, you'll still be actively managed..."

He brings printouts of various mutual funds and uses the morningstar 4 star and 5 star rated funds as the extent of his fundamental analysis.  He, just like everyone on CNBC, is skilled at prognosticating the market without really saying anything either way.  He provides absolutely no, like CNBC, 'actionable intelligence' as I like to call it.

However, when he decides to move $1 million dollars from one mutual fund to another, he does it in $50,000 and $75,000 blocks.  So it takes us about 3 months to move 5% of our portfolio, in 20 separate transactions.  I believe this guy is giving, churn-and-burn a new definition.

If I bring up any question about this guys qualifications, or the fact that we only made 18% ROI when the entire market was up 60% last year, I get looks from the 3 senior board members like I have worms coming out of my mouth. 

Our money manager however does provide the 3 board members with free golf games, free baseball tickets, etc etc. 

Did I mention that the 3 senior board members are also in charge of hiring and firing and discipline, of which I am subject?

I'm considering dropping off this board, however I'm the only one at my place of employment that even knows what the S&P 500 is.  It's very frustrating....



ATM's picture

Dude, resign from that board immediately or at least start keeping a personal log of what's going on what your objections are and anything else that might be used in your defense at your trial because that's why your on the board in the first place.

And who the hell can give free tickets and golf to clients? I'm a registered principal and I think FINRA might take a somewhat jaundiced view of a registered advisor priming the pump with more than $100/yr (I think that's still the limit but it might be even lower.)

Since I work in a somewhat similar field as this guy I'd love to know who it is. He sounds like the worst money manager around and I know lots of them!

Fred Hayek's picture

I would be writing one long cover my ass letter about everything that's wrong and circulating it to everyone who has any interest at all in the situation.  They're counting on the people who care but don't know anything about it to remain ignorant of what's going on.

Thoreau's picture

Stay close to your enemies. Document everything for later use. The mob will thank you.

RichardENixon's picture

Hope you have a good lawyer, sounds like you are the one who will be left holding the bag.

Mr Creosote's picture

Document everything. Bring it back to those paying into the fund and get the board ousted if it isn't too late.

Circumspice's picture

My personal advice, honestly, is to put your complaints in writing, submit it to any higher-ups or authorities who will lend you an ear, and resign. You do have a fiduciary and legal duty to the beneficiaries, perhaps especially so as the only remotely intelligent individual.

Like you said, you're the patsy. When problems get uncovered, they'll use the old person standard, "Well shucks, this big-town investin' stuff seemed pretty gosh-dern hard to li'l ol' me. That's why we hired guys like Biff."

JLee2027's picture

You are their selected scapegoat. Get out of Dodge buddy and the sooner the better.

bingaling's picture

Anyone who has their money managed by someone else is going to be robbed or has already been -from 401k's, pensions, state funds to Ira's for kids educations . How the hell can people be so naive to believe that someone else is better to manage their money is beyond me .

Bear's picture

Not so ... I have a PIMCO (managed) bond fund that has shown great returns consistently ... Go Gross

mix's picture

I live near the swamp ( Springfield, Ill) When the teachers came to rally at the state capitol for more money, they were not allowed to go to TRS building. They have full time security personal and cameras , for a pension fund building. And I am sure the teachers union is a player in this as I belive they have a say on the pension board, which is filled with political hacks. The circle is unbroken.

Nevermind's picture

It's all good. Bailout money, Social Security, or China? They think we're gonna pay 'em back? They'll be getting dollahs with Ben's picture on it, Bernanke that is. 

Fred Hayek's picture

It's all about the Benjamins?!

pitz's picture

Only losing 5% in 2008 is quite a feat.