More than three years before the current financial crisis, in a series
Greenspan, the Wizard of Bubbleland that began on September 14, 2005, I
warned:
Through mortgage-backed securitization, banks now are mere loan
intermediaries that assume no long-term risk on the risky loans they make,
which are sold as securitized debt of unbundled levels of risk to institutional
investors with varying risk appetite commensurate with their varying need for
higher returns. But who are institutional investors? They are mostly pension
funds that manage the money the US working public depends on for retirement. In
other words, the aggregate retirement assets of the working public are exposed
to the risk of the same working public defaulting on their house mortgages.
When a homeowner loses his or her home through default of its mortgage, the
homeowner will also lose his or her retirement nest egg invested in the
securitized mortgage pool, while the banks stay technically solvent. That is
the hidden network of linked financial landmines in a housing bubble financed
by mortgage-backed securitization to which no one is paying attention. The
bursting of the housing bubble will act as a detonator for a massive pension
crisis.
Now, in October 2008, while the US government is busy
bailing out wayward banks, public pension funds operated by states and
municipalities face their worst year of losses in history, exacerbating
cumulative funding shortfalls of past decades of credit bubbles and putting
pressure on distressed state governments to shore them up to avoid pending
default.
In the nine months to the end of September, the average state and municipal
pension fund lost 14.8% of its market value. The loss has deepened as global
financial markets fell sharply in October. The loss has more than doubled the
previous highest loss for state funds, which registered 7.9% for the full year
in 2002. Few market analysts expect equity prices to bottom any time soon, let
alone a recovery, and many are resigned to the prospect of years of asset
deflation and economic stagnation.
California's Calpers, the biggest public pension fund in the US, in the week
ending October 24, reported a loss of 20% of its asset value, or more than $40
billion, in the quarter between July 1 and October 20, 2008. State and local
pension funds comprise a patchwork of 2,700 funds that manage $1.4 trillion on
behalf of 21 million public employees, including teachers, firefighters,
policemen and other municipal workers. About 40% of these funds are
under-funded, meaning that they would not be able to pay the future pensions
promised to public employees.
State governments have raised pension benefits to keep up with inflation,
betting on a growing wealth effect from fund investments to meet higher
payments. It was part of the flawed rationale that called for the privatization
of social security.
Just like the social security trust fund, pension funds are money that belongs
to the workers who are required to contribute into them out of their payroll
deductions, matched by public funds as part of workers’ employment benefits.
These funds are not charity payments from government employers. They are
compulsory savings of public sector workers.
Richard Daley, mayor of Chicago, the home town of Democratic presidential
candidate Senator Barack Obama, has convened a taskforce to address the
shortfalls in Illinois funds. For example, funding for the Police Fund has
fallen to less than 50% of requirement. The situation is actually more ominous.
The calculation is based on an assumption of annual returns of 8%, but very few
funds will reach that level of return in the next few years. Most funds will be
lucky to escape further losses in the current market meltdown.
The city of Chicago would have to start contributing substantially more to the
fund out of its general revenue and from federal and state subsidies. Public
employees are faced with the prospect of being required to contribute more from
their payroll deductions. Chicago is not unique in its public pension problem.
Every city and state of the union is in similar difficulty.
A vicious downward cycle is emerging as state and local governments face lower
tax revenue that puts pressure to cut costs. Congress is pushing for a second
fiscal stimulus package, in part to alleviate pressures on state pension
funding. Nancy Pelosi, speaker of the House of Representatives, cited money
lost from pension funds in her push for an additional $150 billion second
stimulus package.
The public pension funds themselves have limited options. Many are under
pressure to move away from the stock market into less risky investments, but
that would mean suffering more capital loss in this market environment and
reducing returns in the future.
Why are hard-working public employees having to pay more to make up the losses
in their pension funds managed by irresponsible professionals who were supposed
to protect their hard-earned capital when the bankers whose greed was
responsible for the financial tsunami that caused the losses are awarded
obscene golden parachutes? Because, according to Republican candidates Senator
John McCain and governor Sarah Palin, "Joe the Plumber" thinks that forcing
rich bankers to pay for the losses they engineered and put on the backs of
public workers would be to practice "socialism''.
Henry C K Liu is chairman of a New York-based private investment group.
His website is at http://www.henryckliu.com.
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