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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Tyler Durden's picture

When at best one year of payouts will be made based on current funding structure, no, nothing needs to be said. The fund will be insolvent shortly.

Anarchist's picture

The powers that be will just raise taxes, float a bond or borrow some cash from uncle sugar. There will also be high profile budget cuts that target the taxpayer. Lots of long lines getting a license, garbage pickups lessened...etc. It is being done all over the country for other shortfalls. The game of musical chairs will go on for longer than you think.

Cheeky Bastard's picture

The powers that be will just raise taxes, float a bond or borrow some cash from uncle sugar. 


Get to know BABs

velobabe's picture

still going to invest in duracell batteries.

Bear's picture

Bond floats for pensions ... Wow, I wish the X-Geners and Millennials understood the implications of this ... or for that matter the bum boomers who are pushing for this payoff 

ejmoosa's picture

And they say capitalists are greedy?

Mr Lennon Hendrix's picture

'The race to the exit'; on your marks, get set...hey, I didn't say go!

faustian bargain's picture

Whoa....who's this Neil Codell person.

bingaling's picture

Head of the school board in Chicago. Just kidding, I have no idea but WTF ??? With those salaries who the hell needs a pension?

-Michelle-'s picture

He's the Niles Township High School Superintendent.

Thoreau's picture

Now this is some useful, pragmatic information! A list of very local banks to solicit for no-money-down-no-interest loans settled with a handshake and a gun.

DoChenRollingBearing's picture

Good work Cheeky for posting that list of parasites.  Pretty hefty pensions.

Have fun paying them Illinois!  Oh, and don't come looking to me for a bailout, been there and done that.

QQQBall's picture

No kidding, against the payouts, but that is some serious "jack" for sitting around - actually, many will probably go back and make another salary as consultants.

dryam's picture

I didn't have much of a reaction to this thread until I read this.  But now, I'm fucking pissed

Hulk's picture

Your ass would burn even hotter if you knew just how little work these folks have done over their so called careers and if you knew how incompetent these folks are...

This is welfare at its worst....

BumpSkool's picture

Oh I don't know Hulk ... they do pretty important work ... they pass the legislation that lets banks get bailed out - as payback for "campaign Contributions" (oopps, I meant bribes) Anyone who still tries to argue Banks=Good/Politicians=Bad  (or the reverse) (or Repub/Dem BS) has lost the plot. THEY ARE TWINNED... They are working the street together... one is a head-fake for the other and vice-versa. Wake up y'all.

Mr Creosote's picture

Cheeky always delivers the goods. Over 30 teachers pulling in over 250 large just in IL.  Imagine the possibilities in CA. 

Hephasteus's picture

Pay to the Order of

Cheeky Bastard

One Bajillion Banzai Bucks from the 8th dimension.

Then the whole time you work. I hover the fat pension over your head and tell you that it goes away if you get fired. So you teach the stupid crap I want you to teach.

It's the same old trick. Offering to the temple for gain. Presents to the king for favorable judgement. etc etc. Before you know it completely screwed up educational system that leaves people inadequately prepared to even see what they are looking at in situations much less understand them or shape them with reasonable thought. The brightest bulb doesn't have to be the best bulb he just has to crack the other bulbs.

BumpSkool's picture

"Then the whole time you work. I hover the fat pension over your head and tell you that it goes away if you get fired. So you teach the stupid crap I want you to teach."


...and then everyone bitches when people have tenure - which was supposed to eliminate this...

Hephasteus's picture

"which is supposed to eliminate this...."

I think you found the source of the bitching. The tenure should come early and disapper later.

You have no idea how many things I've needed to try to convey or bring to conciousness in people. I can do it but I have to go to very scary areas in very real ways. In the end I spoil the whole thing and render it harmless but it's the same thing with teaching. You can't know an approach is bad until much later and prejudging just makes it worse. And people can fake through the support time and once they've achieved a nearly unreproachable position they can pull the crazy out of the hat.

I also have a jupiter aspect which lessens reactions to things by half. So i'm allowed much more leeway than most other people but it's still not enough.

People also believe that teaching is a superior/inferior function. Where the superior conveys and teaches the inferior. It's not. It's mutual teaching and learning. This allows true learning the superior/inferior approach allows "conditioning" and possibility of taking advantage of it. By teaching people the wrong thing and then taking advantage of the gullibility.

Tenure is a bad thing. It should be replaced with a highly defensible position. In other words a very long drawn out process of fighting the person before being allowed to fire them. But bullet proof. That's not good for anybody.

Problem Is's picture

Excellent post Tyler...

"Alexandra Harris of the Medill Journalism school at Northwestern.."

Nice Work Ms. Harris
You will now be made an offer by the oligarchy to silence you...

Take the CNBC position of "anchorette," the bonus, salary and the complimentary breast enlargements... drink Kool-Aid, file your nails and speak the truth no further...

OR Become a Broke Semi Employed Journalist
Getting shot at, harassed and occasionally jailed...

And occasionally post on ZH and once a year appear on Democracy Now or Truthdig...

As for the latter... best of luck paying off those student loans...

"It's not for the want of employment I'm going,
For tomorrow I sail far away,
For a life of dign-ity, devoid of strife,
On the shores of Amer-i-kay."

Greenhead's picture

People need to go to jail.  If there is a bailout it should be from the taxpayers of the great state of Illinois.  When the pain level gets high enough they will a) begin to either yell and scream and maybe elect different rulers or b) leave the state. 

My brother in law lives in the Chicago area and says the bureaucracy, taxes and red tape are already at all time highs.  Those of us in other states shouldn't have to subsidize those numbskulls for the high level of incompetence and criminality that appears to exist in Illinois. 

On the other hand, there is a kind of justice in seeing the demands from the unions resulting in these just rewards.  Soaking the taxpayers year in and year out results in what?  A bankrupt pension.  Still, where was the oversight, where was the real sense of a fiduciary, where were the grown-ups?

DoChenRollingBearing's picture

Our daughter lives and works in Chicago.  She tells us that the Sales Tax is 10.5%, the highest in the nation.

Crook County's picture

I have a lot of friends I grew up with in that system.  Don't think they are entitled to any Social Security either because they were exempted out of it.  It is really going to get ugly in this state when the SHTF.  I think Blaggo borrowed from this fund to finance a tollway expansion back in the day.  Well at least we can all get to I-80 a little faster as we move to Indiana. 

just sad.

Mr Creosote's picture

I'm paying Social Security and expect squat when I retire.

hambone's picture

Isn't all the debt really nothing more than just another addiction in American?  Addicted to food, addicted to smoking, addicted to binge drinking and alcoholism, addicted to consumerism, addicted to lotteries, credit, addicted to illusions. 

Isn't this whole game just America's unwillingness to accept life for what it is?

In my expat days we lived overseas and had what the company provided.  Was great because it showed us how little was neccessary to be happy and how liberating it was to leave behind the "keeping up w/ the Jones'" rat race. 

But we were lucky because we knew our future had hope / opportunity.  Be frightened once Americans no longer have hope or hand outs...will make for a lot of progressively strange, sad headlines in coming years of murders, suicides, riots, thefts, you name it (and think global).  Not advocating for more handouts but lets be clear about the short term outcome once these are reduced or gone.  This is why many advocate guns and ammo.

We soooo need a depression to clean the system and to force us to put our feet back on the ground and gain perspective on life but avoid societal chaos (ie, the wild west).  My great fear is that the depression will be avoided at all costs and Americans will be totally shocked if/when tshtf and simultaneously the gov will be completely out of bullets or in the hands of the anti-Obama who sees no role for gov.  This could cause a very dangerous period until some sort of new "normal" is set.

We want to stop the bailouts / handouts but I also hope we want to avoid total breakdowns that costs the lives of the innocent.  This is the "managed" depression I'm advocating.

DoChenRollingBearing's picture

Good comments, but I doubt very much that the upcoming depression can be "managed" at all.

Protect your families.  Think, plan, prepare.  It could get VERY bad.

downwiththebanks's picture

. . . addicted to stock-jobbing, home ownership, and derivatives . . .

Addicted to capitalism, and buying stuff one doesn't need.

Insert witty title's picture

as much as i respect your rights of freedom of speech i really wish you would just fuck off.

Freewheelin Franklin's picture

In a related story, but on a positive note, from today's paper:


New Jersey is one of the few states where the pension system is run by on-staff investment teams. According to the minutes of a State Investment Council meeting last November, New Jersey had the top-performing pension system in fiscal year 2009 -- with a gain of 14.2 percent -- compared with an average of minus 19.6 percent among the 44 states that reported returns

As of April 30, investments in the state pension system were up 19.5 percent for the fiscal year, to a total of $68.9 billion.


Mr Creosote's picture

Is that Cheeky with the first comment?

Greenhead's picture


Don't think a managed depression is manageable.  When you have the massive unemployment payments, wellfare and other social payments escalating at the current rate, any cutback will feel like cold turkey to a drug addict, and they will react accordingly.  We have built this trap and, human nature being what it is, the entitlements are now expectations.  Fear will have people in the streets and they will use the threat of violence to try and get back to their "normal".  Tragic as it is Greece showed that huge cutbacks create unrest.  We are a much less homogeneous society and are polarized already.  I am with you, I hope for a peaceable transition but I am not optimistic of that outcome.

hambone's picture

The admin is doing nothing to begin preparing people for any sort of real world.  All of this "stimulus" must be paid for and the OMB's budgets showing higher interest rates, higher taxes, continuing high unemployment, and above trend GDP is garbage. 

People need a leader (a depression coach?) to explain times will be tough but we will get through this together.  We'll keep a floor in place that doesn't allow for the worst outcomes (starvation, mass homelessness, mass uneducated).  But big O is such a piece of shit all he can do is tout the "recovery" and attempt to get folks to feel at ease to spend the last savings they have as we approach much tougher times (don't think this is partisan, I actually hated Bush deux more...hell, I actually voted for big O vote for prez...I had to vote for somebody?).  Anyway, you get my drift. 

If the floor isn't in place, desperate people will take desperate actions and my kids will grow up in an America I won't recognize.  If the cupboards bare or the political pendulum swings, I fear for our cities and suburbs full of paper pushers (like myself).

AVP's picture

I think your Fear is well placed. There is still time to stock up. First and foremost, get yourself a few handguns and a couple of shotguns.

DoChenRollingBearing's picture

Don't forget to buy gold (and silver) as well!

imapopulistnow's picture

Wall Street found an easy mark.  Damn ZH for exposing it.

You Cant Handle the Truth's picture

Gee, Illinois.  Never would have guessed.

Thoreau's picture

Subsisto pensio taxes!

Captain Willard's picture

ZHers: you guys are being way too hard on Leo. He has been very accurately and zealously exposing the pension problems in the US and Canada all along. He is probably wrong about solar stocks. But he has been damn right about this major, major problem. Public employees will be marching in the streets before this one is over.

hambone's picture

Leo is a big boy and does somewhat deserve what he gets because he's promoting to "extend and pretend" the system rather than call for it's much needed demise and renovation (well at least Leo the Bull...there is also Leo the realist looking at the pension systems with a wary eye).  I think that's why folks get pissed at "Leo" (bullish proxy or real?).  Many are tired of those cheering for the next "bull" market that will only just draw out this bullshit for one more highly lucrative and subsequently even more destructive bubble.  It may happen but it only allows us to continue to build elaborate castles on sand w/ high tide coming soon...and the future of our loved ones hanging in the balance.  Nothing personal Leo and wish you well, I just want a stable system that allows for my family to live and let live peacefully.

OK - maybe I'm just calling out the different crowds within ZH and owe Leo an apology.  There are those that are "traders" (maybe Leo) looking to profit regardless the outcome and willing to take either side of the argument vs. those making social commentary and wanting (fixed to) a certain outcome to stabilize the system (btw - the 2nd group are decidedly not good traders).

Renfield's picture

+1 hambone.


"There are those that are "traders" (maybe Leo) looking to profit regardless the outcome and willing to take either side of the argument vs. those making social commentary and wanting (fixed to) a certain outcome to stabilize the system (btw - the 2nd group are decidedly not good traders)."

Guilty of wanting to profit regardless of the outcome.

I trade (very very small-time) on the FX, and one very big reason for this is that I think all these fiat currencies are garbage. So I have no emotional investment in any doing 'better' than any of the others, don't believe in any of them lasting, just watch the charts and pick what looks profitable for that day. This is not investment to me - it's simply much more profitable than earning an honest wage in an honest job that requires skills & training. In other words, I'd rather trade currencies that I'm damn sure are garbage, care for myself & my family, rather than get fleeced by the government and corporates, only to find at the end of a working life that I built their empire rather than my own.

Am I part of the problem? Maybe, but I think ALSO part of the problem are the worker bees who stand in line, work hard, and hand over their earnings to Big Parasite b/c they 'trust'. (Decades of nationalistic programming and paternalistic government create a very docile worker-pool. Someone mentioned slavery above - of course, slavery has been and will always be with us.)

Can't say I feel good about this situation. I don't feel that 'adding liquidity' is particularly useful or good at this time. But, doing something more 'moral'(?) for a living would ensure that a) my & husbands' fleeced parents won't get taken care of; b) we will never own a house or land; c) we would never be able to retire (possibly not a reasonable desire but since realistically we will be unable to work our whole lives and will have no-one to take care of us, I still believe retirement is necessary for us to try for).

Not meaning to go into a rant on you. :-) Just presenting more of the picture, as your comment does resonate with me.

three chord sloth's picture

Whenever I see a story about public employee union pensions I like to know a couple of things:

1. Are the union officers in the same pension or is it separate?

2. What is the funding level of the officers' pension compared to the rank-and-file?

3. What returns are the officers getting compared to the rank-and-file?

I have yet to see a case where the officers are worse off than the rank-and-file. Funny thing, ain't it? The union officials always seem to know how to run their own pension system... yet the failure of their member's system is always blamed on outside forces.

Has anyone seen figures on the teacher's union officials pensions?

Circumspice's picture

Am I missing something, or wouldn't they be in the same boat? By the looks of Illinois's TRS, plenty of higher-ups are on the dole, too. These aren't separately managed accounts, either; that would be a cash-balance plan.

Moreover, the officials' goal is to keep the plan underfunded. I'm not saying union officials try to lose money on investments, but the second they start seeing some returns, they push for more and more benefits. At some point the taxpayer will acquiesce and bail them out. A 60% shortfall, they have discovered, is the level they can extort from Illinois's taxpayers beyond pension returns. I'd say that's about right.

mojine's picture

 ... "Has anyone seen figures on the teacher's union officials pensions?" ...


Is this something Cheeky can find?

seventree's picture

Swaptions? Swaptions? Is there no end to this insanity? Sounds like a particle the Large Hadron Collider would spit out. Except this one won't create a black hole and swallow the whole planet -- just all the teachers in Illinois.

geoffb's picture

So do I have it straight? Basically all the state pension funds are playing blackjack together at a table with Goldman Sachs as the dealer. But instead of getting to 21, the bets are based on the direction of interest rates which GS controls via its proxies in TG and BB? I think I remember how this one ends. ;-)