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The Looming Pension Disaster

Saturday, March 7, 2009, 11:35 AM

As I’ve been writing about in the Martenson Reports over time, including the last one, one of the next shoes to drop is going to be a pension disaster. This too will be more easily measured in trillions than billions.

I am expecting a public pension wreck based on “management” so flawed as to cross over into gross negligence or worse.

March 3 (Bloomberg) -- The Chicago Transit Authority retirement plan had a $1.5 billion hole in its stash of assets in 2007. At the height of a four-year bull market, it didn’t have enough cash on hand to pay its retirees through 2013, meaning it was underfunded to the tune of 62 percent.

The CTA, which manages the second-largest public transit system in the U.S., had to hope for a huge contribution from the Illinois state legislature. That wasn’t going to happen.

Then the authority found an answer.

“We’ve identified the problem and a solution,” said CTA Chairman Carole Brown on April 16, 2007. The agency decided to raise money from a bond sale.

So far so good, eh? I mean especially if you don’t think about it too hard. After all, the only way a scheme to borrow money to plug a fiscal hole can work is if you are earning more from investing that cash that you are paying out in interest. Makes sense right?

Your investment gains have to exceed your interest costs or the scheme becomes a sure-fire money loser.

Well, here’s the punch line:

In the CTA deal, the fund borrowed $1.9 billion by promising to pay bondholders a 6.8 percent return. The proceeds of the bond sale, held in a money market fund, earned 2 percent -- 70 percent less than what the fund was paying for the loan.

Wow. I am speechless. That was the "plan"?

Borrow at 6.5% and earn 2%?

This is an unfortunately accurate illustration of the type of “talent” with which many state pensions have been saddled.

New Jersey did the same thing under Governor Whitman except they borrowed money in 1997 and plowed that borrowed money into stocks with a uniquely horrible sense of timing. New Jersey residents will be paying for that fiscal nightmare for a long, long time.  From the same article as above:

New Jersey Governor Jon Corzine, a former co-chief executive officer of Goldman Sachs, has proposed allowing government pension funds to put off half their pension contributions because of the state’s growing deficit during the recession.

Corzine’s suggestion follows a recent New Jersey pension track record of mistakes. When the state’s pensions were healthy in the 1990s, the state legislature eliminated nearly all of its annual pension contributions for almost a decade, while adding $4.6 billion of benefits.

New Jersey sold $2.75 billion of pension bonds in July 1997. Then-Governor Christine Todd Whitman said at the time that the bonds would save taxpayers $47 billion and make the system fully funded. “You’d be crazy not to have done this,” Whitman said in a Bloomberg News interview in June 1997. “It’s not a gimmick. This is an ongoing benefit to taxpayers.”

Whitman’s prediction hasn’t held up. While the state pays pension bondholders a fixed 7.64 percent interest rate, the fund has earned 4.8 percent annualized since the bond sale, according to Tom Bell, spokesman for the New Jersey Treasury Department.

Now here’s the way that the pension issue gets away from the planners mighty quick. A pension takes money in and then invests it and uses actuarial assumptions (about life expectancy, etc) to estimate how much the fund needs to be “fully funded”.

What the other pensions do is they assume a “rate of return” on the funds. This means that a fund that is earning a 10% return needs a lot less cash to be put in over time than a fund that is earning 5%. As students of the exponential function you now know that even a small percentage gap over time can quickly morph into an untreatable monster.

Meet the monster

Typically, pension funds put 60 percent of their assets in stocks, 30 percent in bonds, 5 percent in real estate and the rest in riskier investments.

Yesterday, we found out that over the past 30 years, the long bond has beaten stocks

Buying 30-year Treasuries is returning more than stocks for the first time since Jimmy Carter was president.

For three decades, owning equities in developed countries earned more than “on-the-run” 30-year government bonds. The advantage reversed after $36 trillion was erased from equity markets since October 2007 amid the first simultaneous recessions in the U.S., Europe and Japan since World War II.

The Ryan Labs Total Return Indices, which track bonds by continually adding the most recently sold security and removing the old one, returned 1,479 percent in 30 years. It beat MSCI’s Gross World index of buying developed market stocks and reinvesting dividends, which added 1,265 percent. “Over the last 30 years there’s been no risk premium,” said Douglas Cliggott, manager of the $81 million Dover Long/Short Sector Fund, which has beaten 92 percent of its peers this year. “It’s potentially earth shattering because the equity market hasn’t delivered the goods.”

30_year_bonds_beat_stocks.jpg

This is actually a fairly important bit of information that deserves to be contemplated by investors everywhere separately from the issue of pensions, but it makes an important point here as well.

Namely, it means that the assumed rates of return for all pensions, public and private, have largely been flawed over the past 30 years.

This is really a staggering insight.

So what are the assumed rates of return for public pensions?

Actuaries consistently permit public pension funds to report artificially high expected rates of return -- most often 8 percent and as much as 8.75 percent. That’s more than the 6.9 percent billionaire investor Warren Buffett sets for his Omaha, Nebraska-based Berkshire Hathaway Inc.’s pension fund. “Public pension promises are huge and, in many cases, funding is woefully inadequate,” Buffett wrote in his 2008 letter to shareholders. “Because the fuse on this time bomb is long, politicians flinch from inflicting tax pain, given that the problems will only become apparent long after these officials have departed.”

Determining how much expected rates of return should be isn’t complicated, says Rowe, who oversees Texas pension funds.

“Why do they choose high expected rates of return?” he says. “The only reason is to sneak through promising a lot to pensioners -- which means worrying about it later. It’s madness.”

As long as the “perpetual growth machine” is chugging along, all of the collective assumptions about pensions more or less work out according to plan. But what happens when a model predicated on exponential expansion not only expands, but retreats?

Well, this is pretty much of an actuarial and financial disaster of biblical proportions. Here’s an example:

The nation’s largest public pension fund, California Public Employees’ Retirement System, has been reporting an expected rate of return of 7.75 percent for the past eight years, and 8 percent before that, according to Calpers spokesman Clark McKinley.

Its annual return during the decade from Dec. 31, 1998, to Dec. 31, 2008, has been 3.32 percent, and last year, when markets tanked, it lost 27 percent.

At its height in October 2007, CalPERS had $260 billion in assets and at the end of 2008 it had $186 billion. Based on the stock market performance this year, we might estimate that CalPERs is now worth somewhere in the vicinity of $140 to $150 billion.

How long would it take CalPERS to “get even”? Well, ignoring inflation, even if we use their extremely generous and woefully unmet assumed rate of return of 7.75% it would take between 8 and 9 years, and that’s assuming that cash in meets cash out the entire time.

If we use their actual 10 year performance as a rate of return, then it’s a 20 year haul to climb back to even, again ignoring inflation.

The monster is the power of compounding working in reverse instead of forward gear.

What does this mean?

Among the many wrenching adjustments that we are just now beginning to face, state legislators must now include a trillion dollar pension shortfall to the list of things that must be negotiated. A government retirement plan can’t go bankrupt, even if it’s insolvent; state treasuries must put up the money if a fund runs dry.

So we are now facing the first actual set of hard choices in several generations. Choices that increasing look like they can no longer be passed to the future. The future is here, it has arrived. Will states decide to pay their retirement obligations, pave roads, educate children, or feed the hungry? These are the choices that now sit before us and I remain skeptical that we will successfully borrow our way out of the predicament this time.

It would seem that decades of intellectually weak and fiscally negligent political leadership has finally caught up with us.

The pain of this adjustment is going to send up a mighty hue and cry from the populace and politicians alike and the response, I fear, will be the same as it always is; print more money.

That is the weak and easy road to take, and so, with history as our guide, we can be nearly 100% sure that our leadership will follow that route as certainly as water will seek a drain. 

 

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24 Comments

Nichoman's picture
Nichoman
Status: Gold Member (Offline)
Joined: Nov 1 2008
Posts: 422
Re: The Looming Pension Disaster

Ya know Chris, your scaring me.  Wink

I've posted several items recently outlining my concerns about our pension systems...your suppose to inform me I'm wrong.  Oh well.  Excellent as always. 

As late Paul Harvey would say...Good Day!  Cool

 

Nichoman

fredbrent's picture
fredbrent
Status: Martenson Brigade Member (Offline)
Joined: Oct 7 2008
Posts: 19
Re: The Looming Pension Disaster

Chris
     Thanks for the excellent survey of the "looming" pension disaster. While I find this and previous articles very interesting and helpful in understanding the dynamics of the current crises my focus is riveted elsewhere.  How many additional "wounds" or "infections" can our already sick and staggering economy/society endure before it falls to its knees and collapses.  I do not know, but it worries me greatly.  I am deeply grateful to  you and this website in helping me escape the matrix, now we fight the war against the inevitable.

     Recently you mentioned moving more into the practical aspects of preparedness and developing local groups and communities.  I eagerly anticipate such a move.  While I have appreciated many of the different posts and threads, It would be very good to hear more detail from you.

Thanks, Brent

horstfam's picture
horstfam
Status: Bronze Member (Offline)
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Posts: 71
Re: The Looming Pension Disaster

I think another wave coming will be credit card defaults. I know this has been mentioned elsewhere on the site, but does anyone have any current projections or information about this?

In my county, unemployment is at 11.5%, or about 30,000 folks looking for work. So, when they lost their last job, did they stop eating? I don't think so. I am guessing a lot of them just kept right on buying groceries- with their credit cards! At some point, they will max out the card and game over- then what? For them personally, each story will be unique, but for the country as a whole, I wonder what the "hit" will be? Are we talking another trillion, or 6 trillion more? The losses will be so large as to wipe out the CC issuers for sure- thus needing another bailout from the government, er, us, right?

Any thoughts would be appreciated. And I, along with a previous commenter, would like to know, "Are there other waves out there we are ignorant/less aware of?" 

Davos's picture
Davos
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Posts: 3620
Re: The Looming Pension Disaster

CM wrote:

"How long would it take CalPERS to "get even"? Well, ignoring inflation, even if we use their extremely generous and woefully unmet assumed rate of return of 7.75% it would take between 8 and 9 years, and that's assuming that cash in meets cash out the entire time." 

 

  •   "Well, ignoring inflation," ---Yikes, I'm thinking hyperinflation because of a debased dollar
  •   "even if we use their extremely generous and woefully unmet assumed rate of return of 7.75%" --- Yikes, I'm thinking PM's might obtain that but anything these momo's invest in won't meet this, everything is "contracting" (cliff diving without the bungie cord.)
Sad to think about retired people enduring this living hell. Sad to think about our children getting a tax bill for this screwup.
 
Take care 

 

r101958's picture
r101958
Status: Martenson Brigade Member (Offline)
Joined: Aug 24 2008
Posts: 257
Re: The Looming Pension Disaster

Thank you for the informative article. This information also helps validate most of Karl Denninger's thoughts this past week (located here: http://market-ticker.denninger.net/archives/852-Whats-Dead-Short-Answer-All-Of-It.html).

Nichoman's picture
Nichoman
Status: Gold Member (Offline)
Joined: Nov 1 2008
Posts: 422
Re: The Looming Pension Disaster

r101958 wrote:

Thank you for the informative article. This information also helps validate most of Karl Denninger's thoughts this past week (located here: http://market-ticker.denninger.net/archives/852-Whats-Dead-Short-Answer-All-Of-It.html).

Facts are Facts.

On a broad scale...hard to not essentially agree with his broad points.  

Key are the rates of evolution of these projections.   Which were all interested in.

 

Nichoman

jerry_lee's picture
jerry_lee
Status: Martenson Brigade Member (Offline)
Joined: Sep 24 2008
Posts: 126
Re: The Looming Pension Disaster

He's only talking about apocalypse...

No one talks about the weather no more.

All this talk about the apocalypse

What other lips can tell the score?

Boyhood trips to the corner store..

Sunny days just like before.

Apocalypse no! I can't listen no more.

Start some tomatoes on another shore.

Buy enough oats not a second before

Too much apocalypse

Is making me sore

Not that I'm panicked...not that I'm scared

But who is my neighbor when the shelves are all bare?

He's only talking about apocalypse...

No one talks about the weather no more.

All this talk about apocalypse

What other lips can tell the score?

Linda K's picture
Linda K
Status: Bronze Member (Offline)
Joined: Aug 23 2008
Posts: 56
Re: The Looming Pension Disaster

jerry_lee

Someone told me only last week that poetry might become more important to us as times get rougher. It was a poet, of course, but if there's still any operating system of balances or action/reaction at work in our future then I agree. Soul food all around.

I hope Sam Linder didn't hang himself quite yet - and reads this post. Thanks all.

jerry_lee's picture
jerry_lee
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Posts: 126
Re: The Looming Pension Disaster

Poetry that is truth telling- not escapism, not a reinforcing of the shroud of denial, not rose colored naivete- most certainly can serve us in our night of need.

My post is just the way my brain works. Usually there's a melody as well.

It may not rise to the level of Poetry (with a capital P, which rhymes with...). but it is part of my contribution.

Thanks for the affirmation Linda!

cat233's picture
cat233
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Re: The Looming Pension Disaster

Jerry,

That was wonderful, thank you for sharing.  If you ever want to just talk about the weather let me know, sometimes I just don't want to think about this stuff.

Cat

SamLinder's picture
SamLinder
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Posts: 1499
Re: The Looming Pension Disaster

Linda K wrote:

jerry_lee

Someone told me only last week that poetry might become more important to us as times get rougher. It was a poet, of course, but if there's still any operating system of balances or action/reaction at work in our future then I agree. Soul food all around.

I hope Sam Linder didn't hang himself quite yet - and reads this post. Thanks all.

R O T F L M A O!  Laughing

No, Linda - I haven't done myself in yet - but thanks for asking!

jerry_lee's poetry is only one thing we'll need. Humor is another thing we'll need in spades!

Mike Pilat's picture
Mike Pilat
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Re: The Looming Pension Disaster

I've had a bit of an urge lately to see a live classical concert or theater performance...it's been a while and I do need outlets to forget about this from time to time. The weather was great today, getting outside was good.

SamLinder's picture
SamLinder
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Re: The Looming Pension Disaster

cat233's picture
cat233
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Re: The Looming Pension Disaster

Mike Pilat wrote:
I've had a bit of an urge lately to see a live classical concert or theater performance...it's been a while and I do need outlets to forget about this from time to time. The weather was great today, getting outside was good.

Mike,

It was beautiful here at the beach, 82 and sunny.  Ditto for tomorrow, I plan to spend most of the day with friends... Outside.  Cool

Cat

.'s picture
.
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Re: The Looming Pension Disaster

Mr. Martenson,

Thank you for posting this to the non subscriber section.  Your work is excellent and much appreciated.

Dogs_In_A_Pile's picture
Dogs_In_A_Pile
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Re: The Looming Pension Disaster

Mike Pilat wrote:
I've had a bit of an urge lately to see a live classical concert or theater performance...it's been a while and I do need outlets to forget about this from time to time. The weather was great today, getting outside was good.

Mike -

Live music of any sort is an amazingly refreshing and rejuvenating tonic - even if only for a few hours.

I'm headed to Richmond next week to see Railroad Earth and Jackass Flats.  Superb musicians - but you need to like folk-ballad-bluegrass newgrass to enjoy Railroad Earth, and just plain old, lightning fast picking bluegrass to enjoy Jackass Flats.

Two great bands and a nice 4 hour break from ht real world.

Any chance you can make it to Richmond on the 21st?  Can't remember when you were leaving for Spain.

hucklejohn's picture
hucklejohn
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Posts: 281
Re: The Looming Pension Disaster

Indeed, there is a looming pension fund disaster.  And, as mentioned above, a wave of credit card defaults is coming, credit card companies as well as credit card holders.  And what about insurance companies having more & more trouble making there annuity contract payments?  And with increased unemployment & diminishing incomes, the psychological effects are unpredictable.  I second the need for us to move on to a discussion of the practicalities of preparing for an environment of food, water, gas, electricity shortages.

kemosavvy's picture
kemosavvy
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Posts: 254
Re: The Looming Pension Disaster

Eventually the debts of the FUTURE will have to be shrunk down.

The only other way around resizing the debts is to print enough money to inflate it away, which like we have seen has been the current actions of the government. I guess the legality (and political suicide) of shrinking the retirees benefits is a barrier to a workable solution.

The one story in the news that makes me think someone gets the idea that "unless we get out from underneath this debt than we have no chance" is Ford Motor Company. They just cancelled $10.4B in debt (with stock and some cash) and are working with unions to fund retiree health care with stock. This is the first example I have seen of a company working to eliminate it's debt without looking for private capital.

 

 

kemosavvy's picture
kemosavvy
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Re: The Looming Pension Disaster

hucklejohn,

pension funds and insurance compnaies are the ones the government is protecting by quasi-nationalizing citigroup, basically ring-fencing the bondholders form further losses. the bondholders are for the most part insurance compnaies, mutual bond funds, and pension funds. those groups can ill afford another loss and the gov't is well aware of the domino fall if they lose the appearance of stability.

I also think AIG has been a ruse for the gov't to prop up these ins. co's and pension funds, of course some speculators got paid off but by and large ins. co's and pension funds used AIG as a backstop for CDO's, CMO's, MBS's and the taxpayer is now paying off.

the conspiracy theory is that most of this is to protect not so much the rich but instead the baby boomer and the retiree at the expense of the next five generations.

 

maveri's picture
maveri
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Re: The Looming Pension Disaster

Dogs_In_A_Pile wrote:

Mike -

Live music of any sort is an amazingly refreshing and rejuvenating tonic - even if only for a few hours.

Gerald Celente reckons you will see a revival of entertainment - mainly due to people wanting to have at least something joyful in a dismal situation.

kemosavvy's picture
kemosavvy
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Posts: 254
Re: The Looming Pension Disaster

i remember reading something about a year ago about how PBGC (pension benefit guaranty corp), a federal pension fund was in a particuarly large financial bind and would need to shore up its capital in hurry to survive. that was last summer, since then i haven't heard much but reckon i will probably be hearing a bunch more.

if the pbgc fails to pay up, then it is the taxpayers responsibility to foot the bill, we may be talking about a few hundred more billion here as well. i'll do the research and get back on this thread. anyone else know much about the pbgc?

 

Dogs_In_A_Pile's picture
Dogs_In_A_Pile
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Posts: 2603
Re: The Looming Pension Disaster

maveri wrote:

Gerald Celente reckons you will see a revival of entertainment - mainly due to people wanting to have at least something joyful in a dismal situation.

Revival?  Kismet?  Perhaps - check the theme of Floyd Fest 8

http://across-the-way.com/index.php?pr=ffhome 

I bought my tickets in December.

Four days of great music and community and the occasional whiff of patchouli oil on unwashed bodies.

 

Mike Pilat's picture
Mike Pilat
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Posts: 929
Re: The Looming Pension Disaster

Dogs: I should be around on the 21st and able to go to Richmond. Let me know what's up.

Jarhett's picture
Jarhett
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Joined: Nov 21 2008
Posts: 132
Re: The Looming Pension Disaster

I want to move to virginia to live near dogs

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