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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seventree's picture

And another thing: this is only the fourth-riskiest investment portfolio for a pension fund in the U.S ???!!

Ye gods what do the other three look like?

downwiththebanks's picture

And who does the rating?

Lehman Brothers, probably!

Caviar Emptor's picture


It's time we added a new thread: American Retirement Assets: The Last Bastion. 

As we progress through a time of further deflation, giant holes in retirement and pension funds will become too huge to ignore, just in time for the rising ranks of retirement age Americans to begin withdrawals. 

This will be the political battleground of the century, the crucible in which the ugly reality of paper wealth and casino capitalism meets the red faces of angry Americans. And it will apply to retirement assets across the board, not only pensions but all accumulated tax-advantaged stores of wealth. Like a run on the banks, there is more than a passing chance that Americans accelerate withdrawals out of concern. And there's more than a chance that these funds will get restricted, taxed and regulated. How will Wall Street fare once the last significant pile of cash gets drawn down? Illinois will be a good test case. But there will be lots more installments to this story.

DoChenRollingBearing's picture

Caviar Emptor writes good stuff.


When you see that avatar with the tin of fish eggs, wake up and read it twice!

Heed his warnings!  The end may be near and very ugly.

mrdenis's picture

And the crock of gold at the end of the rainbow for all the hard working teachers ...http://www.championnews.net/article.php?sid=1023

taineasy's picture

Why doesn't Vegas just invite all the underfunded pension fund managers to a comp weekend where its winner take all. The Mirage would be a nice venue. At least someone will come out a winner.

Renfield's picture


There are a number of pension fund managers/union bigwigs/government tools/corporate piggies that I'd like to invite somewhere for a nice weekend, or just a nice dinner - Borgia-style.

StychoKiller's picture

Kinda related is the following:


"NY State Shell Game - Municipalities Borrow from Pension Fund to make Required Pension Fund Contributions"

The tail is not only wagging the dog, it appears to be doing so after the dog ate it!

thesapein's picture

New York Avoids Shutdown as Lawmakers Pass Weekly Stopgap Bills


Remington IV's picture

Don't worry , Obama will get to that issue ---- between golf games and bashing BP

Akrunner907's picture

Can someone help me out?  Do they publish how much TRS has paid to the counter parties for any exercised CDS's?

PeterSchump's picture

Only one critique, probably mentioned multiple times prior, the move to socialism happened a long time ago. Anyone who denies this is not worthy of a retort, for their capability of rational, reasoned thinking is nonexistant. Not a pure socialism by any means, but the farcist variety that has been exposed here in many posts. That a public pension fund would engage in such behavior is a testament as to how perverted we have become.

downwiththebanks's picture


The means of production are no longer in private hands anymore!

Government has taken over all the key industries.

And all without letting corporate executives, shareholders, and boards of directors know they've been replaced.

Funny thing, this new socialism.

The Merchant of Venice's picture

Uncle Sam has helped himself to nearly half of corporate income for the last 50 years.

The means of production were in private hands in name only.

Fix It Again Timmy's picture

Back to the brick question - is it a brick of coke or a brick of hash?

hedgeless_horseman's picture

It is a Brazillian, Russian, Indian, Chinese swaption sold to Illinois Teachers by the Giant Squid. 

enobittep's picture

This is incredible.  I am anxious to see if this event represents the tip of the next iceberg which will be ripping a massive hole in the hull of the global economy.  Is it really possible that the  investment banks loaded up numerous public pension funds (worldwide) with these toxic assets in their mad quest to generate fees & profits for themselves?  If this turns into the mess I suspect, the feds / banks will not be so successful sweeping this problem away by sacking our kids with a decades of higher taxes and significantly reduced standard of living - they already took the brunt in crisis #1.  This time around it is going to impact the aging and retiring baby boom generation directly in reduced retirement security.  Maybe this will wake up the sleeping dog and trigger the long awaited political backlash that throws all the DC bumbs out on their butts - and puts some bankers in jail.  Accountability needs to be demonstrated in order to be learned.  

NP40's picture

Here' some interesting tickets to speed the Apocolypse.

Huckabee and Mean Jean Schmidt

Can run on a platform of insulting gay war heroes who want to get married.

Barney Frank and Barack Obama
One's a great orator and the other is a great orifice.

Mitch McConnell and Orrin Hatch
Could run on a platform of vast banking deregulation for multiple Mormon wives.

Steny Hoyer and Chris Dodd
The "forked tongue" tour.

Really want to see revolution in America ? Pass a law banning TV remotes.

Privatus's picture

Teacher can't count. And that's going to cost. If you don't know who is the dumb money in the room, it's you. Color me unsympathetic that these lifelong taxeaters won't be getting the benefits of their ill-gotten gains. There is some kind of justice going on.

DoChenRollingBearing's picture

+ $1225. 

No make that: + $55,000.

My nomination for best short post of the day.

downwiththebanks's picture

The public sector workers to which you refer with such scorn made one simple mistake:  they believed the benefits of the system would trickle down to them because they had a contract.

Little did they know that the whole POINT of the contract was to enable the pillage of their savings by the banks, facilitated by a government wholly-owned by those same banks.

If only your hatred for those greedy people out to make $40,000 after six years of college would apply equally to the bankers who rape babies and steal millions . . . 

I won't hold my breath.

killben's picture

"The Fed is surely aware of this, and will do everything in its power to prevent a catastrophic collapse."


With that conniving scoundrel at the helm of the Fed YOU CAN REST ASSURED ABOUT THAT!!

Is lynching a person a crime??


Brett in Manhattan's picture

Anyone catch Steve Keen on WABC 77 radio? He was just a guest on the John Batchlor show. Some good stuff. Keen said he was gonna be in NYC in early July for some speaking gigs.

old naughty's picture

Too few greenback printers for too many DOA retirement funds, muni bonds, euro junks, soverign debts...its too late to stop the tide. Redemption avalanche will be here soon, the day of the reckoning.

But please don't give up on humanity. 

Alcoholic Native American's picture


This is the digital age, it's all digital.  It only takes a few keystrokes, and if things get really bad they can probably write programs to do all the work.

walküre's picture

What I really want to know is:



Ned Zeppelin's picture

". . . . 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."


poorold's picture

History will look back and judge these "investment managers" in the harshest of terms.


These are not INVESTMENTS, these are GAMBLING BETS.

An "investment" provides the opportunity for all invested to end up with more because the investment generates increases in productivity, lower costs, etc.  In effect, an investment is made with the express intent of providing a good or service that yields an increased benefit to society.

By and large, the crap referred to in this article is necessarily a "less than zero" game.  The gain by one party is equally offset by the loss of the other party and the "investment advisor" takes his cut upfront.

Sound familiar?  It should, Vegas is built on that principal.

The Merchant of Venice's picture

These pensioners pay no social security.  If you're on the hook for your own pension as a 401k you're still paying social security.

Get ready for the new normal.  No more 401ks.  No more defined benefit pensions.  The strategic risk posed by all the insolvent pensions will force the Fed to stroke the invisible hand and combine all of these different retirement schemes into a single retirement pension overseen by the Executive branch of the Federal Government.

It will arrive in 5 years time.  It will resemble the Chilean model if we're lucky.

Geoff-UK's picture

Agree--except I don't think we have five years.