America's Next Top Bubble...large pension funds

America's next top bubble. Coming soon to your idiot box. Indeed, the large pension funds of America are living in a dream. The dream that 8% annual returns are a reality going forward.

If we were to stop and scratch beneath the surface and ask "why were there so many school districts, municipalities, churches, hospitals, etc investing in risky CDOs, MBSs and Swaps?" we may begin to see the ugly truth that is being aggressively ignored by mass media and much of the investing public in regards to pension funds nationwide.

The truth is that these pension funds are something we really need to be worried about and working pro-actively to improve and sequester from risk. The "Magic 8" figure has not changed since 2001, though the world indeed has.

consulting firm Callan Associates:

Many plans have held onto an 8% return expectation though thick and thin. Such return assumptions partly reflect the heady years of the 1990s bull market. Public pension plans posted a median, annualized return of 9.3% over the past 25 years, but just 3.9% over the past 10.

Tick, tock...tick, tock. Christmas is over. No more toys, no matter how loud you cry.

For those of you who have not, I seriously suggest checking out "While America Aged" . It is certainly Roger Lowenstein's lowest profile book and arguably, his best work. Not surprisingly, it has flown largely beneath the radar and received very little fanfare in proportion to the severity of the issue it attempts to tackle.

The truth scares the Ostrich. But burying head in sand, no matter how firmly will not help avoid becoming lunch. That Hyena will snack on you whether you see it coming or not. Here is a now 2.5 year old review of the book by the New York Times.

Unlike many of the orthodox finance issues we discuss and confront daily, this is a huge macro factor that goes on ignored. It has the potential and the magnitude to shock equity, bond, labor markets and beyond. In fact, we can easily argue that the seismic activity has already begun and that we are looking at the wrong craters for the cause of the tremors.

Informing yourself is the ultimate armament in today's world. This issue is the largest and most ignored of these "weapons". Playing daily, weekly and monthly strategies can make you millions. But playing year and decade long strategies, with proper research and investment can lead to gains in the billions...or...if handled improperly...losses of even greater magnitude.

Both the gift and the curse of current young generations is that smart, conservative investing will become our hallmark. To the joys of some and the utter, miserable, failure and poverty of others.

Comments (22)

Sep 18, 2010

This is interesting, but don't you think the problem is perpetuated further because the baby boomer's are going into retirement. I really think this country needs to have immigration reform or another baby boom to support the system, because it only worked and looked like a great idea because there were able men and women to support the system, and people going into retirement. What do you do now about social security, medicare and the 70% of the economy, consumption?

Sep 18, 2010

I look at the baby boomer retirements as a built-in factor of the issue, that's why I didn't mention it specifically. When you say "immigration reform" what do you mean exactly? The reason "it" worked IMHO is because the "world economic pie" so-to-speak was accessible to everyone from 1946-1991. What we have seen in the aftermath of the Cold War is "the guy who was happy with a handful of rice and a tin cup of polluted water, now wants his filet mignon and pricey pinot". Increasing competition, globalization and the break-down of social, cultural and economic barriers which have stood (in some cases) for thousands of years are leading to a world where "kicking back and relaxing" (all that retirement really is from an economic evolutionary standpoint) is going to become more and more of a luxury.

Eventually, many (if not most) people will have to work until or close to their death. I personally don't have a problem with that. What "you do"...is you look people in the face you tell them that they had the privilege of being present during one of the greatest periods of peace and prosperity in world history and that times are about to get tougher. You tell them, they are still fortunate to be where they are and to fight for their piece of the pie...because you no longer have the power to give it to them for simply punching in/out 9/5.

Is that going to happen? No. Politicians do not get re-elected by telling the truth and unfortunately...Americans have begun to emulate Europeans in way too many of the important facets of living and surviving.

Sep 18, 2010

65 was the "retirement age" in the 1940s, and now people are living quite a bit longer, no? Plus people are a lot more likely to be working in an office than in a factory, which is probably a healthier working environment. I think we can squeeze a few more years out of them.

Sep 18, 2010

Many of the people in the reverse meritocracy of the public sector who get these massive pension payouts (teachers, police officers, etc) are not public sector employees because they want to serve the public, but rather because they are not qualified enough to get a good private sector job. It makes no sense that taxpayers should be on the hook for some deadbeat state government employee's guaranteed pension, while the rest of the country, employed in the private sector, is responsible for taking market risk and investing for their own retirement. But, largely because of unions and the perpetuated myth that public sector work is somehow more honorable than work in the private sector, this is the current state of affairs.

Beyond the basic fact that these pension funds should not exist, they are quite simply the dumbest money out there. Compensation at the largest pension funds is abysmal, especially given that they run 10's of billions of dollars (what's 1 bps on $50 billion?). Too big to invest in the best hedge funds (at least at a position size that would have an impact), but too lacking in talent and bench depth to run money internally. No big surprise that they have been taken for a ride - someone has to be on the other side of every trade.

Mish's blog has been covering the impending pension crisis for a while, and shit is now starting to hit the fan with state budget shortfalls. Lots of good anecdotal evidence of the absurdity of the whole pension system.

http://globaleconomicanalysis.blogspot.com/
More fun to come...

    • 1
Sep 18, 2010

op should work for WSJ

Sep 18, 2010

I mentioned immigration reform because it is crucial to brining in talented individuals from across the world, as well as to increase the population. Just look at what's going on in Japan, they sell more senior diapers than baby diapers. IMO, immigration has always played a crucial part in this county's development, and I think it will have to play a crucial role in the country today. Both to compete with the world, and to have able men and women to support the current system.

Sep 18, 2010

@non-target

the population is increasing just fine. Illegal immigrants and welfare fostered groups (black, white, red, green, purple, yellow...socialistic sloth is not race denominated) do a great job of reproducing. The issue isn't that our population is dwindling, it is that there are too many people being born who will likely never become contributing members of the society. We are not Japan. We are the bizzaro Japan, all of the travails and then some. If you do a little research on "the brain drain" you will find that much of American ingenuity post-WW2 was spearheaded by former Nazi and Soviet bloc researchers. In today's world those "intellectual refugees" have options throughout the world. You can't simply increase immigration. Quality immigrant labor has become very much like free agency in pro sports. To the highest bidder goes the top talent. America is no longer the top destination and you cannot replace the economic throughput of one Sergei Brin with a thousand and one illegals who provide little marginal utility while usurping government tax-theft resources. You're on the right track, but confuse mass population with mass productivity. We don't necessarily need more people, we need greater productivity. More of one does not necessarily lead to more of the other. And remember LEGAL IMMIGRATION has always played a crucial part in this country's development.

@ivysaur

don't know if that's a compliment or insult but you get a silver banana for your general belligerence.

Sep 18, 2010

yes we need qualified immigrants who are EB1 not the H1B knucleheads in this country.

Sep 18, 2010

Being someone coming out of college, I'm pumped for this much needed reality check that will come oh-so-hard to the people who have turned a deaf ear to the matter and to the current administration that could have worked on this instead of universal healthcare. The unfortunate part of this is they're going to blame wall street when we run out of money.

Sep 18, 2010

Pension funds are guaranteed but the US Government. Rest assured that the tax payer will be on the hook for this disaster.

Sep 18, 2010

Midas,

I find this interesting as the Public Sector complains about each and every move against their precious unions but cannot accept that their "Guarenteed" raises, health benefits and pensions are not what people in the private sector get. They really do live in their own little fantasy. Here in NJ, again with the Jersey Politics and references, our public unions, particularly our own extortion authority known as the NJEA, have refused to make any compromise because they have been given everything they've asked for and when the governor asks for a modest contribution of 8.5% of income to cover individual pensions, they are met with the ire of the unions and state senators who refuse to see the tough predicament that the governor is in. In all fairness, he did say he would fund the pensions this year, but is unable to because no one wants to take the budget cuts that need to be made. Corzine gave it without fighting any battle, and the public unions took him to the bank. If a private sector worker tried that, they would not have a job if they used the union's tactics.

I cannot even have a serious talk with my friends in the public sector because they are brainwashed into believing that mother union is right without accepting the burden that the taxpayer has to face to pay for their benefits. My friends who are teachers refuse to talk to me when the subject of the NJEA (dependind on your persective, it's the New Jersey Education Association or the New Jersey Extortion Association) comes up because my demeanor changes from rational and reasonable to outright angry and disgusted over their ignorance about how the non-public sector employees live. Their view of normal, like this 8% rate of return, is a dream and we are, unfortunately, the people that bare the brunt of their burden. Like TARP, the defecit and what will soon be XXX-Flation, the taxpayers will shoulder the responsibility of paying for it.

Anthony,

Look at the state of California for guidance into how screwed the pensions are and in turn, the tax payers are. They have a pension that is underfunded by hundreds of billions of dollars, that, if the pension goes bust or is forced to liquidate, the state government is on the hook for. How can you expect a state to opperate effectively when they are on the hook for a significant portion of public sector debt. So, when CalPERS makes a trade that goes the other way and goes from 100 cents on the dollar to pennies on the dollar, it is scary to consider how much the taxpayers of California will be on the hook for. So, $200+ Billion in unfunded liabilities, coupled with a few bad trades could spell the end of California.

The big question I have is whether a state can actually declare bankruptcy and whether a firm other than Goldman is going to be able to try and collect the fees from this?

Sep 18, 2010

This is a huge reason why the expansion of all forms of government really scare me. Just look at the benefits government workers get. It isn't the immediate cost that worries me, it is the cost that we sign up for that scares the shit out of me. I see no reason why the any public worker should have a pension when their private counterparts do not.

Risk=Reward. Public workers have unions, they do not face the cut throat lay offs that we in the private sector face. Their risk exposure is much lower than the rest of us. Yet they have all these amazing benefits.

Totally support Christie in what he is doing in NJ.

Sep 19, 2010

The public/private sector compensation debate is an interesting one. I remember reading an academic paper that compared total compensation and concluded that low-education government workers were overcompensated in relation to their private peers while highly educated government workers were undercompensated compared to their peers. I'll look for the reference, but I doubt I'll be able to find it.

Sep 19, 2010

Frieds,

The young corpulent Jedi called Christie is your only hope. Use search function to locate his mind trick on pubic sector (no, not a typo) drone #2346902624...it's an oldie but a goody. Your state sucks btw and I say that with no ill will towards you. I just get dry heave attacks thinking about it's populist politics and the illegality of pumping my own gas.

Sep 19, 2010

Over 3 million of the private sector pensions are frozen.

Some parts of the public workforce is so overvalued. There are so many people trying to become teachers in NJ because of the benefits. (3 month vacations, meet the status quo, babysit kids, health care, sick/free days, repeated curriculum every year, free periods, etc.) I understand they are in charge of teaching the next generation, but the amount of incompetent teachers in our classrooms is pretty much fraudulent. Some teachers are literally babysitters that give the students busy work to get through the day. One of the highest paid teachers at my school was the PE teacher.

SEPTA (Philly transportation) striked last year... Really? They drive buses and operate the subway and railway, which is vital but they're not performing emergency care on stab/bullet wound victims. And it was conveniently planned to take place during the World Series and the city wouldn't want that... (Phillies lost anyway) I agree with Frieds, the public workforce is extorting the public which includes themselves, but they're too blind to see it. 5% increased wages and an increase in pension. Thanks for jacking up the fare prices. I'm sure Philadelphia could have easily found someone to train and replace the workers seeing how far the level of unemployment climbed.

I think "Porscha" summed it up nicely: i dnt c y septa went on strike in da first place like dey ws fukn up wit ppl goin places like da mall for instance.. shyt ws reckless for dat week... js to gt more money, do yall already gt enuff money, yall sum fukn bus drivers.. fuk outta here.. septa nutty as shyt yo..

Sep 19, 2010

MMM,

NJ suburbs > Outer-boroughs

Anyway, on my way home from a certain outer-borough to my home in NJ yesterday, I read this article in Bloomberg Markets Magazine.

http://www.bloomberg.com/news/2010-09-09/cleaning-...
Some highlights:

" In 2000, more than half of the 50 states had the funds to cover what they owed. By 2008, that number had shrunk to four -- Florida, New York, Washington and Wisconsin -- as total unfunded liabilities reached a record $1 trillion, according to a February 2010 report by the Pew Center on the States that uses the latest available data."

"Calpers made a series of disastrous bets on real estate after letting its internal risk controls break down and ceding too much control to outside investment advisers during the housing bubble. The pension fund has earned an annualized 2.88 percent return on its assets through the 10 years ended on June 30, far below the 7.75 percent it must collect every year to meet its obligations to 1.6 million beneficiaries."

This one got me. Seriously, 2.88% annual return!!!

"Calpers's unfunded liabilities amounted to $240 billion as of 2008, leaving it with only half of the assets it needs to make its required payouts"

This is just Calpers, but the article makes some similar points to the WSJ article. I brought this up in my post the other day (where I mentioned demographics in USA), but I don't see any realistic solutions to this problem. The only thing I think we can do are try and figure out the economic implications of this problem (how will this affect treasuries, equities, commodities, etc), and how can we make investment decisions to profit off of this event. George Soros says that no bet is too large if you know it is certain... perhaps we should figure out what is certain and profit off of it.

Sep 19, 2010
LIBOR:

MMM,

NJ suburbs > Outer-boroughs

Anyway, on my way home from a certain outer-borough to my home in NJ yesterday, I read this article in Bloomberg Markets Magazine.

http://www.bloomberg.com/news/2010-09-09/cleaning-...
Some highlights:

" In 2000, more than half of the 50 states had the funds to cover what they owed. By 2008, that number had shrunk to four -- Florida, New York, Washington and Wisconsin -- as total unfunded liabilities reached a record $1 trillion, according to a February 2010 report by the Pew Center on the States that uses the latest available data."

"Calpers made a series of disastrous bets on real estate after letting its internal risk controls break down and ceding too much control to outside investment advisers during the housing bubble. The pension fund has earned an annualized 2.88 percent return on its assets through the 10 years ended on June 30, far below the 7.75 percent it must collect every year to meet its obligations to 1.6 million beneficiaries."

This one got me. Seriously, 2.88% annual return!!!

"Calpers's unfunded liabilities amounted to $240 billion as of 2008, leaving it with only half of the assets it needs to make its required payouts"

This is just Calpers, but the article makes some similar points to the WSJ article. I brought this up in my post the other day (where I mentioned demographics in USA), but I don't see any realistic solutions to this problem. The only thing I think we can do are try and figure out the economic implications of this problem (how will this affect treasuries, equities, commodities, etc), and how can we make investment decisions to profit off of this event. George Soros says that no bet is too large if you know it is certain... perhaps we should figure out what is certain and profit off of it.

Private schools are the answer LIBOR. You have a good head on your shoulders, but are still a part of that liberal idiot edgamakayshnl machinery. There is NO future with public schools. You'll understand that once you start subsidizing this useless machinery. Knowledge, much like money is power...it cannot come for free. In fact, even private educational institutions don't do as good a job as they could. Education in life has always been the individual's responsibility. The public school machine is just one of a million ways in which America retards and falsely equips kids for the real world they will soon face.

As far as your comment about NJ burbs > outer boroughs again it depends, you have some real good private high schools in the Bx and Bk. That having been said NJ is the richest state in the Union per capita, so it's hard to refute the claim. That having been said, off a blind taste test I'd always buy the life experience of a NY kid>NJ kid, but then again...you know I'm biased in this regard.

Btw, Soros is an excellent example of how wealthy liberals create a moat for their wealth via breadcrumb spreading amongst the peasantry. The man is one of the great scourges upon not only American but all civilized societies. Amazing how much credit he still gets for Druckenmiller's work.

Sep 19, 2010

Midas,

Yup, and there is no ill will taken. Say what you want about any other state, but truly, on the strong survive in Jersey. Christie has a lot to do. He won't get it done because of people like Steve Sweeney who refuse to acknowledge the tough place he is in. If Sweeney wants to see the 3.1 Billion dollars paid to the pension, he better have 3.1 Billion dollars worth of cuts to make across the board to our budget but then that's 3.1 Billion dollars not going to other groups that may need it more than the pension so they can operate as usual, since our state can't even bother accepting furlough days an as option. The moment we even discuss the idea of a furlough day, the public workers flip out and demand that they not happen for fear of striking or expect to be paid overtime if they are forced to work on a furlough day.

StopDrop,

This is why I have no respect for the teachers unions and despise the teachers that blindly accept the NJEA as god. When people like Barbara Kashishian, head of the NJEA, cannot look beyond the outstanding benefits and the crapshoot they lovingly call tenure and see that the private sector does not have those same rights, they refuse to even stop and acknowledge this difference. Just to put a little perspective, Ms. Kashishian takes home both a teacher's salary, a pensionable value of ~90K and sees an additional ~250,000, not including her deferred comp and state pension, as head of the NJEA. Her pay as head of the NJEA is ~75,000 more than Christie makes, her total taxable income is approximately twice what he makes and he can only hold one job as Governor of the State of NJ, being governor. So she's taking home her fair share and has the greatest degree of leverage over the state's damned no child left behind laws. She can let the children pass, but not have them taught a thing.

When you have that kind of extortion going on, it really is a shame that you have to look at it and lower your head in shame when you consider everything. How can we allow our educators to hold our children hostage? One of my family friends was complaining that she was "Forced" to send home an NJEA sponsored propaganda flier about Christie's budget cuts when she supported them and was willing to take a pay freeze in order to keep her job. The problem with the union is that there are two distinct classes of people, there are there realists who understand that they can't have their cake and eat it to and the flock of sheep who assume that the union knows best. It is the realists who get the situation and are unfortunately bound by the NJEA and cannot speak up. As long as the Pension Funds find ways to extort the government and, in turn, the taxpayers, by being the in back pocket of senators and having the tools to hold our kids ransom, they will further be the death of us.

Anthony,

That magic 8% does not work and when your job as a pension is to generate safe returns for your employees, I wonder what will happen when a pension has a negative return for the year or makes a risky bet on CDOs and acts as the seller on what should be a sound issue, only to see it default. I think the scariest part will be the ensuing law suits both between the pensioners and the fund itself for breach of fiduciary responsibility, and between the fund and the state for payment of unfunded liabilities. Looks like the tax payer will be screwed regardless.

Just as an aside, here's something from SNL that everyone would appreciate.

http://www.hulu.com/watch/144719/saturday-night-li...

Sep 19, 2010

Midas,

Private schools are the answer LIBOR. You have a good head on your shoulders, but are still a part of that liberal idiot edgamakayshnl machinery. There is NO future with public schools. You'll understand that once you start subsidizing this useless machinery. Knowledge, much like money is power...it cannot come for free. In fact, even private educational institutions don't do as good a job as they could. Education in life has always been the individual's responsibility. The public school machine is just one of a million ways in which America retards and falsely equips kids for the real world they will soon face.

I am not sure whether I agree with you or not, as my own experience was to the contrary. I am more inclined to believe that private schools, excluding those considered to be parochial, tend to be better but it really depends on the district you are in and where you live. I went to a top-5 public school in the state of NJ. My public school is considered to be one of the top in the country by US News and World Report, having earned a silver medal designation despite being an open enrollment (read: Public) school. I would be inclined to believe, based on past US News and World Report rankings, this would put my public school in the top 200 of schools nationally. The problem with saying that one is inherently better than another is that it really does come down to location. If I lived in Newark, Mountainside or Edison, I would have gone to a private school because the quality of education would have been significantly better. Because I grew up where I did, I was able to attend an amazing public school. If you are lucky enough to live in a district where you can benefit outright from the system despite the stigmata of being publicly educated, it is not a bad thing. Ultimately, it does come down to the quality of education of your district versus what private institutions are available.

Sep 19, 2010
Frieds:

Midas,

Private schools are the answer LIBOR. You have a good head on your shoulders, but are still a part of that liberal idiot edgamakayshnl machinery. There is NO future with public schools. You'll understand that once you start subsidizing this useless machinery. Knowledge, much like money is power...it cannot come for free. In fact, even private educational institutions don't do as good a job as they could. Education in life has always been the individual's responsibility. The public school machine is just one of a million ways in which America retards and falsely equips kids for the real world they will soon face.

I am not sure whether I agree with you or not, as my own experience was to the contrary. I am more inclined to believe that private schools, excluding those considered to be parochial, tend to be better but it really depends on the district you are in and where you live. I went to a top-5 public school in the state of NJ. My public school is considered to be one of the top in the country by US News and World Report, having earned a silver medal designation despite being an open enrollment (read: Public) school. I would be inclined to believe, based on past US News and World Report rankings, this would put my public school in the top 200 of schools nationally. The problem with saying that one is inherently better than another is that it really does come down to location. If I lived in Newark, Mountainside or Edison, I would have gone to a private school because the quality of education would have been significantly better. Because I grew up where I did, I was able to attend an amazing public school. If you are lucky enough to live in a district where you can benefit outright from the system despite the stigmata of being publicly educated, it is not a bad thing. Ultimately, it does come down to the quality of education of your district versus what private institutions are available.

Don't disagree. I was alluding to the economic aspect. Private schools aren't a drain on the economy the way public schools are. Academically, there are too many variables to make blanket statements. I don't believe anything in life is a given and that is why I will always support the private school alternative.

Your point about Christie is well taken. The teacher's union is a far bigger political bully than any of the purported "corporate villains" we always hear about. No need to get into a diatribe here, as I am sure you're well aware of the tactics permitted to unions in regards to lobbying. The reality is that Jersey is a prime example of what happens to the beneficiaries of trickle-down economics once the spigot is squeezed.

Sep 20, 2010
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Yours truly,
The Young Investor

Nov 9, 2012