A long, long time ago, back in 2008 when most of today's hedge fund analysts were still stressing over what to wear to prom, a man named Bernard Madoff was arrested for bilking unsuspecting investors out of $65 billion. Madoff ran what is traditionally referred to as a ponzi scheme in which new investments were solicited as a means to fund massive redemptions that otherwise would have resulted in a collapse of his fund long before the FBI finally caught up with his scheme.
But, Madoff was eventually caught and in 2009 he was sentenced to 150 years in prison for his scheme.
Ironically, many of our states and cities today are running very similar ponzi schemes (aka "massively underfunded pension funds"), using taxpayer money nonetheless, but it's completely legal and not many people seem to notice and/or care.
Take, for example, the Chicago Teachers' Pension Fund ("CTPF") which has roughly $10 billion in assets to cover $21 billion in future payment obligations. The fund has to payout roughly $1.4 billion to retirees each year to cover benefits. That said, in 2016 it actually lost $28 million on it's $10 billion in assets.
So how did they make up the difference? Well, the CTPF simply took the $700 million that was contributed to the fund in 2016 from taxpayers and the $192 million contributed by teachers from their paychecks, money that was intended to be invested until those teachers retired, and gave it to current retirees. Put another way, just like Madoff, the CTPF takes money from 'new investors' (current teachers) and uses it to fund redemptions (benefit payments to retirees) even though the managers of the fund know that current claims don't have a chance of ever being paid in full.
Now, you could argue that returns in 2016 were not normal which, for the sake of Chicago's taxpayers, we hope is true. That said, even if the fund earns the 5.6% returns that it's averaged for the past 10 years going forward, it will still have to borrow roughly $850 million from new contributions each year just to cover annual benefit payments.
As a side note, we would point out that Chicago's teachers have made roughly 1.4% off their investments in hedge funds, on average, over the past 5 years...which is probably just under the 1.5% management fee they pay to those same hedge funds.
Of course, you could also argue that reducing principal balances could be justified to the extent the number of future retirees is expected to decline versus current retirees. Unfortunately, that argument is also flawed as the number of current teachers actually exceeds the number of current retirees...not to mention the fact that their salaries, and therefore future benefit packages, are nearly double those of current benefit recipients.
Source: Chicago City Wire.
Of course, like most financial grenades with a huge tail risk, the devastating consequences of America's failed public pensions will not be addressed until it's already too late. Unfortunately, with ~$5 trillion in underfunded pension obligations in the public sector alone, the pension catastrophe will be too large for even America's overly generous taxpayers to bail out.