Two few months ago we disclosed how the Illinois Teachers' Retirement System (TRS) was doing all it can to become the next AIG. In addition to, or maybe precisely due to, its deplorable fundamental condition, which can be summarized as being 61% underfunded on its $33.7 billion in assets, with a performance record of down $4.4 billion in 2009 and 5% in 2008, the fund, courtesy of a detailed analysis by Alexandra Harris of the Medill Journalism school at Northwestern, was found to be on its way to trying to become a veritable self-made TBTF: as was described then, "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." In other words, TRS was selling substantial amounts of derivatives, which held the fund's other assets as hostage in case the collateral calls started coming in, as should the market broadly decline, the value of the downside derivatives would "increase" and the seller (in this case TRS) would need to pledge ever more collateral against these wrong way bets. Not only that, but the Fund is currently getting annihilated on its curve exposure: "TRS appears to be betting that long-term Treasury yields will greatly increase" we wrote back then. So as a result of i) its massive underfunded fundamentals and ii) a bet that the market would turn bullish, i.e., spreads would drop (they are rising), and treasuries would plunge (we all know where they are today), which was supposed to happen by now but isn't as the economy is now officially double dipping, the fund has basically thrown in the towel and is proceeding with liquidations. The problem there is that due to its derivative exposure, liquidations now become self-reinforcing, as more cash needs to be pledged as collateral in a declining market, and the AIG death spiral we all know and love, follows. The only thing missing is for Goldman to raise its overnight variation margin requirements and it's game over, as we get a brand new AIG on our hands. And since Goldman is among the 60 or so asset managers that actually decide how the fund invests its meager assets, it is fully aware of its precarious position, and it is a sure bet that Goldman is currently deciding when to pull the plug on the TRS life support.
All this is direct consequence of the disclosure in Crain's Chicago earlier that "Illinois Teachers' Retirement System, Springfield, plans to sell $3 billion in investments, or about 10% of its $33.1 billion in assets, in the current fiscal year to pay pension benefits, according to Dave Urbanek, public information officer."
More on the start of the TRS (not to be confused with Total Return Swap, an instrument, ironically, which we are sure the TRS is actively (ab)using to lever up its UST exposure by up to 50:1) toxic spiral:
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.
There is, of course, the obligatory spin:
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.
The only question one has is whether as part of this "appropriate rebalancing" the TRS has covered its increasingly out of the money derivatives? And since the answer is most likely "no", as that would be the painful but prudent thing to do, and has likely only sold off instruments which are now losing more and more value with each passing day, each day will merely bring more and more P&L losses to the fund. Which means that as the market continues selling off, the derivatives will require that more assets are sold, which will push the market further lower, which will demand furhter margin calls, and so forth ad Chapter 7.
To be sure, the insolvent state of Illinois has not helped:
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.
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.