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Are Pensions the Next AIG?

Submitted by Leo Kolivakis on 08/24/2010 22:39 -0400

Tyler Durden of Zero Hedge posted an excellent comment, Illinois
Teachers' Retirement System Enters The Death Spiral: AIG Wannabe's
Go-For-Broke Strategy Fails As Pension Fund Begins Liquidations.

I quote the concluding remarks, but it's worth reading the entire comment:

Alas,
at this point it is too late: for TRS, and likely for many, many other
comparable pension funds, which had hoped that the Fed would by now
inflate the economy, and fix their massively incorrect investment
exposure, the jig may be up. As liquidations have already commenced, the
fund is beyond the point where it can "extend and pretend", and absent
the market staging a dramatic rally, government bonds plunging, and
risk spreads on CDS collapsing, the fund is likely doomed to a slow at
first, then ever faster death.

Then one day, Goldman's risk
officers will call the TRS back office, and advise them that due to its
"suddenly riskier profile" established in no small part courtesy of
Goldman's investment allocation advice, the collateral requirements
have gone up by 50%. The next step is either Maiden Lane 4... or not.
For the sake of the 355,000 full-time, part-time and substitute public
school teachers and administrators working outside the city of Chicago,
we hope that the TRS has now been inducted into the hall of the Too
Big To Fail, as otherwise roughly $34 billion in (underfunded) pensions
are about to disappear.

You can read the Bloomberg article, Illinois Pension May Sell $3 Billion of Assets to Pay Benefits as well as the Chicago Tribune article. According to Barry Burr of Pensions & Investments, the system is the fifth Illinois statewide defined benefit plan to sell off investments this fiscal year to pay benefits:

Illinois
State Universities Retirement System, Champaign, expects to sell $1.2
billion in investments from its $12.2 billion defined benefit fund this
fiscal year to raise liquidity to pay benefits to participants.

The Illinois State Board of Investment,
Chicago, could sell $840 million investments from its $9.9 billion
fund to pay benefits of the Illinois State Employees' Retirement
System, Illinois Judges' Retirement System and Illinois General
Assembly Retirement System. ISBI oversees the investments of the three
systems.

The liquidity stress from the
investment sales at the five plans could force each of them to
restructure their strategic asset allocations, terminate investment
managers and search for new managers.

Illinois Teachers sold $290
million in investments so far this month and $200 million last month
because of a lack of state contributions.

“Without the monthly
state contribution, TRS estimates sales of roughly $3 billion for the
entire fiscal year, or approximately $250 million every month,” Mr.
Urbanek said in a statement in response to an inquiry.

So far,
TRS has accomplished the investment liquidation through “appropriate
rebalancing,” Mr. Urbanek said in the statement. “As the year
progresses, this approach will no longer be sufficient to cover the
total amount of benefit payments and more targeted asset sales will
need to be considered.

“TRS staff continues to study the impacts
of the current liquidity situation on the total portfolio and
recommendations will be made as necessary to adjust targets.

These
changes could include revisions to the system's target asset allocation
and termination of investment manager relationships as 10% or more of
the portfolio is liquidated to pay benefits this fiscal year,” he said.

Mr.
Urbanek said the investment sales could force changes in the system's
current asset allocation impacting whether it could meet its current
8.5% target rate of return.

“In the current market environment,
there are significant market opportunities to institutional investors
with available capital. In the absence of the required contribution from
the state, TRS and the other Illinois pension systems will no longer
be able to participate in these opportunities,” he said.

R.V.
Kuhns, the system's investment consultant, is evaluating possible
allocation changes for liquidity needs as they arise, Mr. Urbanek
added. He said it was “impossible” to know details of possible searches
or terminations at this time.

Since the start of the fiscal year
on July 1 through Aug. 20, the system has received only $90 million in
contributions from the state. For the current fiscal year, ending June
30, 2011, the system requested $2.35 billion in contributions from the
state, Mr. Urbanek said.

In the last
fiscal year, the system sold $1.3 billion in assets to pay pension
benefits; it received $170.4 million in employer contributions and $899
million in member contributions, while requesting $2.08 billion in
employer contributions alone.

TRS' current asset allocation is
U.S. equities, 30.5%; international equities, 20.3%; fixed income,
17.5%; real estate, 9.6%; real return, 9.3%; private equity, 8.3%;
absolute return, 3.6%; and short-term investments, 0.9%.

When
the financial crisis erupted, it first hit banks, insurance companies,
hedge funds, real estate/ private equity funds, asset managers, and then
hit pension funds. But pensions remain very vulnerable because as
interest rates fall and assets dwindle, their pension deficits explode,
and if they need money to cover benefits, well guess what, they're
forced to sell liquid stocks to meet those obligations.

And they typically sell stocks at the worst possible time. This is what happened to the Caisse in 2008 when they lost $40 billion
and got whacked hard with non-bank asset-backed commercial paper
(ABCP), forcing them to shore up liquidity at the worst possible time.

Other funds like PSPIB also got hit
(to a lesser extent) with ABCP but they benefited from net inflows, so
they weren't forced to sell stocks to meet pension obligations. The same
goes for CPPIB, which suffered a 19% loss in FY2009, but kept buying stocks throughout the crisis.

But
unlike the Caisse, PSPIB, and CPPIB, the Illinois TRS is not managed
anywhere near as well, and they took stupid risks to meet unrealistic
investment targets. Moreover, instead of learning from their mistakes,
they continued taking excessive risks to try to address their widening
pension deficit.

When you're a mature pension plan, you got to manage your liquidity risk very carefully. Go back to read my conversation with Jean Turmel
who sits on the board of Ontario Teachers' Pension Plan (OTPP). They
manage liquidity risk looking ahead 18 months. The folks over at
Illinois TRS should fly over to Toronto and have a serious discussion
with OTPP's senior managers.

Finally, today I read that Nortel retirees stand to lose one third of pension and that Ontario will toughen pension funding requirements
for companies and bolster its guarantee fund as it works to fix a
pension system hit hard by the financial crisis (better late than
never).

While pensions are finally getting the attention they deserve, I'm
worried that they're the next AIG (but much, much bigger). The Fed is
going to do what it can to bail out pensions, but I have serious doubts that even they are fully aware of the magnitude of the pension Ponzi
and how it could easily topple the global financial system (ever tried
quantifying total aggregate pension leverage and counterparty risk? Good
luck!).

When
pensions are forced to liquidate to meet pension obligations, we should
all be concerned. Luckily, there are some huge sovereign wealth funds
that stand ready to pick up shares from struggling US pension funds, but
if this becomes a pattern among US (and global) pension
funds, watch out, the pension tsunami will have far reaching effects which will make the whole AIG fiasco look like a walk in the park.

***TRS responds***

Please see TRS's response to "death spiral" comments.

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Wed, 08/25/2010 - 13:23 | 543256 Leo Kolivakis

***TRS responds***

Please see TRS's response to "death spiral" comments.

Wed, 08/25/2010 - 13:38 | 543402 ZackAttack

I've read TRS's reply twice and I don't see how it's material why they're liquidating. 'Oh, the big pocket has a hole in it, but there's still plenty of money in *this* smaller pocket, so we're just using some of it while we wait to be refilled from the bigger pocket.'

All that matters is, believing that Illinois is a dead state walking, traders can look at their larger positions and lean on them, wait for them to puke. That's the death spiral. I don't understand how the claim that it's not trading losses affects that outcome.

Wed, 08/25/2010 - 09:02 | 542573 ZackAttack

They were given a lesson in 2008.

They were handed an artificial rally to sell into in 2009 and into early 2010.

They had months and months to take risk off. If they failed to do so, consider it evolution in action. This debacle absolutely must NOT be allowed to become a federal responsibility. The state's pensioners are solely its own responsibility.

And, since you mention the name, why the fuck isn't AIG in runoff mode right now?

Wed, 08/25/2010 - 08:35 | 542564 three chord sloth

Pensions are doomed.

Whether your pension is defined benefit, defined contribution, or a SS style pass through makes no difference; they are all at their root built upon the earning power of the following generations. All of those pieces of paper in all of those pension plans are just chits; claims on a part of your children's and grandchildren's earnings. If those workers are not doing well, then the retirees are not going to do well.

Since much of the world is in a demographic swoon these plans are already running uphill. Add in the hollowing effects of globalism and you've got a formula for collapse. After all, these generous Western style pensions were designed based on first world salaries earned in first world nations -- and since the purpose of globalism is to eliminate the first world... well, the money is simply not going to be there.

Free haircuts for everybody! No barbers required!

Wed, 08/25/2010 - 08:17 | 542529 Bruce Krasting

Leo, There are no sovereign wealth funds gobbling up US stocks as you suggest.

You are supposed to be the perma bull who always buys the dips. Then you write this and I wonder how you can still talk the markets up at every turn.

The biggest buyers of stock, your pension funds, are regularly selling what the own. Like Tyler Durden has said, this could go into a death spiral.

Are you still 'contructive" on this market? Just interested....

Wed, 08/25/2010 - 06:30 | 542467 TooBearish

The Fed is going to do what it can to bail out pensions, but I have serious doubts that even they are fully aware of the magnitude of the pension Ponzi and how it could easily topple the global financial system (ever tried quantifying total aggregate pension leverage and counterparty risk?

The Fed could lend to anyone according to their charter, but making loans to pensions would imply even more leverage and debt. How would the Fed "bailout" pensions? The only thing the Fed can do is to print and inflate to try an reblow the equity/financial asset bubble.

So far the only thing Ben is blowing successfully is Larry Summer's old shriveled up (@$k...

Wed, 08/25/2010 - 06:17 | 542460 exportbank

The average amount of total pension benefits promised to a public sector retiree is over $1,000,000.- sure seems like game over to me. Our elected officials at every level of government committed the private sector citizen to obligations greater than their total income (100% tax won't cover it). Any combination of thieves and fools usually has a humorous ending - put a stock salesman and a politician in the same room and the results won't be pretty but very profitable for both of them...

You don't even have to worry about anything other than pensions and health care - those two alone will break the system.

Wed, 08/25/2010 - 04:40 | 542429 zaphod

Thats easy, does Goldman have stacked positions on the other side of pension fund's trades?

Wed, 08/25/2010 - 03:14 | 542410 Helix6

And do it now, while the fund still has a decent amount of assets.

Wed, 08/25/2010 - 03:13 | 542409 Helix6

Best move at this point: divvie up the assets into 401K accounts for the plan beneficiaries in proportion to their vestment. No point in making any bones about an insolvent fund, and unfair to saddle taxpayers with debt to try to make good on funds with unrealistic projections (and therefore similarly unrealistic contributions).

Wed, 08/25/2010 - 02:17 | 542389 StychoKiller

What I don't get is: Why the question mark in the article's title? Change the title to an affirmative statement -- a lot of folks here already suspected as much.

Wed, 08/25/2010 - 00:40 | 542337 whatsinaname

pensions need to get some solar stocks.

Wed, 08/25/2010 - 00:29 | 542322 chindit13

The problem is far bigger than any SWF. Underfunded pensions in the US are massive, but on a percentage basis, Japan's might be even larger (and its population is older). Japan's supposed savings are no salve, because the two major plans (Postal Savings and Postal Insurance) were managed just as badly, or with the same misplaced optimism, as the country's pensions. On a relative basis, the Singaporean and Norwegian SWFs are chump change, and unless the entire world becomes two-SUV households, no OPEC country can do much to help, particularly if they keep funding 167 story white elephants for their bastard step brothers or indoor ski resorts for 45 degree climates. And China has its own set of woes.

I do recall that when Russia blew up and the ruble tumbled, Gorbachev received a pension that was the equivalent of $10/month. Perhaps that is why he started doing AMEX ads, though one wonders why AMEX would grant a card to someone with that earning power. In any event, Russia found a way out, though a booming rest of the world helped.

I am not confident there is a similar solution to what the US and Japan face. I agree with Leo that the pension problem makes AIG look like a minor checking overdraft. Even more than the RE-related debt collapse, it is the pension problem that makes me think we face only two possible futures, depending on whether or not we go 24/7 with the printing press. It seems there is only hyperdeflation or hyperinflation.

Wed, 08/25/2010 - 00:12 | 542301 Jason Bourne

If the pension is a ponzi and was designed to only function properly in excellent market conditions - TOO FUCKING BAD - Liquidate, adjust, payout less do whatever the fuck you have to do - but I am not paying for it directly or indirectly via the government or the Fucking Fed.

Yes I know if pensions blow up everybody is affected - FINE thats the way it should be. I don't want anybody getting special help - if whatever their fucking business is doesn't work then their business model dies - Too Fucking Bad.

While we are at it - if you can't pay your mortgage - then you are in foreclosure - its a process that gives you a little bit of time to pay up or work it out. After that you can't pay - then you're out. Yes you are OUT. Go rent something you can afford to pay for.

No I don't give a shit if my entire neighborhood is foreclosed on. I will deal with it if I am the last person standing. Don't worry about me or the value of the remaining homes. Purge the fucking system! so we can begin to move forward.

Oh and if you don't pay your loans or go bankrupt or walk away from loan obligations - I don't give a fuck if you lost your job, or incurred some other hardship (actually I do care - but for the purposes of the what the consequences are its DOESN'T FUCKING MATTER), then you are NOT allow to borrow money for a minimum of 3-5 years from any institution. I've had enough of ASSHOLES who walk away because they are underwater in their debts and don't feel that it suits them to pay the debt THEY AGREED TO. You can walk away but it will be a minimum of 3-5 years before you can borrow again.

Wed, 08/25/2010 - 06:53 | 542473 Robslob

I think Obama Bin Laden just junked you for saying that...wtf?

Wed, 08/25/2010 - 01:29 | 542366 Montgomery Burns

I've got no problem with that as long as the same rules apply across the board to big businesses as well as individuals.

Tue, 08/24/2010 - 23:31 | 542237 traderjoe

The Fed can't bail them out. Can't bail out the states, muni's, etc. There might be a couple of small moves for the next 2-3 months just to keep the sheeple distracted. But once a true liquidity event comes (I think sometime this Fall), the Fed will have to move to Plan B - a new currency, defaults, etc. - whatever it might be.

Tue, 08/24/2010 - 23:51 | 542267 CulturalEngineer

In the end a central bank... especially one dependent of economic mysticism... can't make an economy work.

You have to have incentives aligned with making useful things and performing honest worthwhile services... all with equal protection under the law and a level playing field.

That isn't the Wall Street/D.C. model.

Tue, 08/24/2010 - 23:20 | 542223 CulturalEngineer

Between the effects of technology on the movement of money and credit...

Combined with the corruption in credit creation, leverage and governance...

Virtually worldwide...

Suggest that while auditing the Fed is a fine idea...

Its not enough.

It's time to AUDIT the PLANET!

I have a feeling its not going to add up... not even close.

Tue, 08/24/2010 - 22:56 | 542178 Robslob

8.5% return...lmao...maybe they need to become a credit card company or something.

I say - Liquidate...tough shit...nothing is guaranteed...not even a 401K annual return...so why should an underfunded pension become the publics problem?

Answer: It's not.

Wed, 08/25/2010 - 03:09 | 542408 Helix6

Amen

Wed, 08/25/2010 - 00:12 | 542294 El Hosel

"When pensions are forced to liquidate to meet pension obligations, we should all be concerned"

They can't even sniff meeting obligations, how is that for a reason to be concerned?

Leo, don't tell me, you finally see something you don't like after it was dropped on your head?

Are Pensions the Next AIG?

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