Leveraged Pension Funds

While unionized teachers may still call young analysts “Banksters,” the intial root of their hatred is simple. They lost out. Not too long ago, underpaid pension fund managers squandered retirement dollars on mindlessly complicated MBS deals with greedy banksters. Ya, right.

A little after this affair made headlines, Novy-Marx, a Kellogg professor, wrote a paper describing that pension funds were massively underfunded, even way before the crash. To Novy-Marx, the problem was the overly zealous 8% return that these fund managers had promised and contracted. With the help of one of his students, the two estimated the unfunded gap to be over 3 trillion dollars- a figure that scared some to believe that a ruckus in the bond market was a sure fate. When I first read their paper, I could not help but say- “holy shit, that’s a big fucking number.”

Today I still feel the exact same way. An 8% discount rate is simply unachievable by the same morons who were exploited during the boom and bust. Perhaps my language might be a bit one sided. But now, my bias is thoroughly supported, especially since some pension fund managers are attempting to leverage their funds in order to provide the promised 8% annual return. That’s right, instead of renegotiating their contracts with state and local governments; pension fund managers are doubling down.

Reuters estimates that the typical return for these funds are about 4%. In order for fund managers to meet the 8% mark, pension funds would have to leverage $3 for every $1 in assets. It’s dangerous and downright retarded. I could not help to think about Hayman Capital’s Kyle Bass saying, “you can’t paint the mirror just because you’re ugly.” Let us hope they do not blame this impending mess on us again....