Tuesday, March 31, 2009

Viva La Vida G20?



A follow-up to yesterday's comment on the giant experiment, someone sent me a WSJ blog article stating that Cerberus's equity stake in Chrysler's auto company to be eliminated:

Cerberus Capital Management will lose its equity stake in Chrysler LLC’s struggling automotive company as a condition of the Treasury Department’s bailout deal with the U.S. auto maker, according to several people familiar with the matter.

The New York private-equity firm purchased an 80% stake in Chrysler in 2007, promising to bolster the auto maker’s performance by operating as an independent company. The plan, however, collapsed due to an unprecedented slowdown in the U.S. auto industry and a lack of capital at the auto maker to weather the storm.

One Obama administration official, speaking on the condition of anonymity, said Cerberus’s equity stake no longer holds value and said the firm’s ownership will come to an end. In term sheets released by the Treasury Department on Monday, the government said Chrysler’s restructuring “at a minimum will require extinguishing the vast majority of Chrysler’s outstanding secured debt and all of its unsecured debt and equity.”

Cerberus will maintain a controlling stake in Chrysler’s financing arm, Chrysler Financial, according to two people briefed on the plan. Cerberus will utilize the first $2 billion in proceeds from its Chrysler Financial holding to backstop a loan allocated to Chrysler automotive in December by the Treasury Department.

In December, when Chrysler was lobbying Congress for financial support, Cerberus said it would make considerable concessions in order to encourage the government to prop the auto maker up, including surrendering equity, foregoing profits and giving up board seats.

“A viable long-term restructuring of Chrysler’s auto manufacturing business will require concessions by all relevant constituencies,” Cerberus said in a statement at the time. “In order to achieve that goal Cerberus has advised the Treasury that it would contribute its equity in Chrysler automotive to labor and creditors as currency to facilitate the accommodations necessary to affect the restructuring.”

Cerberus still holds a portion of Chrysler’s secured debt, and that likely will also be restructured under new terms the Obama administration is laying out for Chrysler.

The Treasury Department lent Chrysler $4 billion in December, and is considering lending billions more to keep it afloat.

The move comes as Mr. Obama’s auto task force is looking to hammer out over the next 30 days an alliance between Chrysler and Italian auto maker Fiat LLC. The government is offering an additional $6 billion in capital if the two sides can hammer out an acceptable deal.

Fiat would take a stake in Chrysler in exchange for giving the auto maker technology, such as fuel-efficient car platforms and engines. Under the deal, Fiat would be required to build cars and engines in the U.S., and Chrysler would have to pay back the $6 billion before Fiat can take control of Chrysler.

Global Pensions reports that interim loans advanced to General Motors by the governments of Canada and Ontario cannot be used to shore up underfunded pension liabilities:

In a joint statement, the two governments said they would advance up to C$3bn (US$2.4bn) to General Motors of Canada and C$1bn for Chrysler Canada to assist the companies while they undertake additional work as part of their ongoing restructuring efforts.

But it said the loans could not be used for pension scheme funding or to pay off debts to parent companies or taxes.

Canada minister of finance Jim Flaherty said: "Together with the Government of Ontario, we are working in conjunction with the US Government to create a viable industry and to maintain Canada's share of Canada-US production going forward.

"The interim loans to General Motors and Chrysler reflect our priorities to both protect our economy and exercise firm oversight over taxpayer dollars."
Canada minister of industry Tony Clement said: "While the restructuring plans represent progress, they do not go far enough to ensure the long-term viability of these companies.

“Therefore, we are not certifying their proposals. Together with our US counterparts we believe that further fundamental changes are needed."

In conjunction with the US Government, the governments of Canada and Ontario are requesting that both companies undertake additional work to ensure their future competitiveness and that all stakeholders contribute appropriately to improving the overall cost structures in their plans.

It will be interesting to see how unions handle the contentious issue of underfunded pensions at the big auto companies. All I can say is that they'd better take a closer look at the health of their pension plans and get outside expert advice to make sure they are being properly managed.

In other pension news, Dutch pension funds ABP and PME announced their recovery plans:

The €208bn (US$281bn) ABP pension fund will increase contributions by 3 percentage points, withhold indexation and de-risk some of its investments in a bid to return to solvency within five years.

The scheme, which saw its coverage ratio fall dramatically as a result of the financial crisis, announced a 1 percentage point increase to contributions as of 1 July this year, with a further 2 point increase between January 2010 and 2014, and changes to its risk allocation.

Doing so, ABP said it hoped it would be able to protect member benefits and not have to cut payments, although it added indexation would not take place.

The fund also said it would reduce the risk of its investments during the recovery period, as required by the FTK law which governs pension plans.

In a statement, ABP chairman of the board of governors Elco Brinkman said “We must now take measures to make ABP healthy again in both the short and long term. We will do all we can to avoid reductions of pension rights.

“Unfortunately, the measures have consequences for our participants and former participants. We have strived to distribute the worst effects in as balanced a manner as possible between employers, employees, former participants and pensioners.”

ABP said it projected a return to minimum solvency in four years and expected to reach a funding ratio above the minimum 105% within five years, reducing the need for drastic measures.

At the end of 2008 its coverage ratio stood at around 90%. It added, even without alterations to its contribution, indexation and risk policies, it would return to solvency in this time.

The fund added it hoped to return to ‘full’ funding of 125% within 13 years and would monitor the situation. If the economy improved more rapidly than projected, it would revise its recovery plan and reduce contributions accordingly.

Should the situation deteriorate, it reserved the right to make further changes.

Under Dutch law, all pension funds with a funding level below 105% must submit a recovery plan to the Dutch pensions regulator De Nederlandsche Bank (DNB) ahead of 1 April.

In late February by the Dutch government announced an extension to the recovery period, from three years to five, as a result of the severity of the crisis and uncertainty over the global economic outlook (Globalpensions.com; 23 February 2009).

The €18.7bn Dutch metal workers’ pension scheme PME also announced details of its recovery plan.

The fund, which saw its coverage ratio fall from 135% at the end of 2007 to 90% by the end of 2008, said it expected to reach 105% solvency in five years.

It would achieve this through a 1 percentage point increase in contributions, from 22% to 23%, and by not offering indexation on pension payments while the coverage ratio remained below 105%.

Yesterday, the health service retirement system PFZW announced details of its own recovery plan, which would see pension indexation frozen for four years (Globalpensions.com; 30 March 2009)
As you can read above, Dutch laws take pension funding very seriously. If a pension fund is underfunded, it has to present a recovery plan to authorities and follow-up on its progress on returning to minimum solvency again.

But there are bigger issues at hand. As leaders prepare to meet in London for the G20, the London Times reports that France's President Nicolas Sarkozy threatened to walk out of the global summit:

President Sarkozy yesterday threatened to wreck the London summit if France’s demands for tougher financial regulation are not met.

France will not accept a G20 that produces a “false success with language that sounds good but contains no commitments”, his advisers said.

Asked if this meant a possible walk-out, Xavier Musca, Mr Sarkozy’s deputy chief of staff for economic affairs, said: “A basic rule with nuclear deterrence is that you do not say at what point you will use the weapon.”

The French threat dramatically raised the temperature hours before President Obama arrives in London today. If carried through, it would ruin a summit for which Mr Brown and Mr Obama have high ambitions, believing it vital to international recovery.

Mr Sarkozy, who blames the “Anglo-Saxons” for causing the economic crisis, told his ministers last week that he would leave Mr Brown’s summit “if it does not work out”.

A deal to tighten regulation will be one of the key features of the G20 accord but France wants a global financial regulator, an idea fiercely opposed by the United States and Britain. Mr Brown has described the notion as ridiculous.

Germany and other nations are reported to be against a global regulator and sources said that President Sarkozy must know that the proposal would not make progress.

Instead, countries will agree that their national regulators should cooperate more. So-called colleges of supervisors are likely to be established to monitor the activities of companies that operate in several countries.

British officials said it looked as if Mr Sarkozy was picking a fight he could present as a victory back home.

Mr Sarkozy’s threat underlines the emerging splits between world leaders. Germany and France have led opposition to plans to coordinate public spending, championed by the Administration of President Obama.

The importance of action to ease the economic decline will be underlined today by a report from the OECD, the umbrella group for Western democracies. It now expects the economies of its 30 member nations to slump by 4.3 per cent this year, against the 0.4 per cent drop that it forecast last November.

The group also warns that unemployment will reach 10 per cent by next year in most developed nations.

The Toronto Star reports that British Prime Minister Gordon Brown called today for a new morality in the halls of high finance as he sought to set a positive note for the sharply divided meeting of G20 world leaders:

Brown has been grasping for ways to bring a sense of unity to Thursday's meeting of the G20, which includes major economies from around the globe.

But his hope that leaders would agree to kick-start their economies with massive new government spending has been pushed aside after strong objections from European nations led by Germany and France.

And, on the eve of the summit, a report on French President Nicolas Sarkozy's attitude toward the whole exercise has added to the internal tensions within the G20. The French daily Le Figaro is saying that Sarkozy has told associates he will walk out ofthe conference if nations do not agree to his radical proposal to bring financial markets under international regulation.

The idea is a non-starter with the United States, Britain and some other G20 countries.

With many of the leaders – including U.S. President Barack Obama and Canadian Prime Minister Stephen Harper – scheduled to arrive in London later today, Brown continued his intense efforts to set the stage for the meeting on the global economic recession.

In a speech at London's historic St. Paul's Cathedral, he sought to speak to the growing public conviction in Britain and elsewhere that the current financial meltdown was the result of unrestrained greed and risk-taking by banks and financial houses with an international reach.

"I believe that the unsupervised globalization of our financial markets did not only cross national boundaries – it crossed moral boundaries," he said. "Most people want a market that is free, but not values-free, a society that is fair but not laissez-faire.

"And so across the world, our task is to agree global economic rules that reflect our enduring values."

Restoring faith in financial markets will be one of the key aims of G20 leaders. Although the summit is unlikely to adopt the French idea of international control of banks, the leaders will endorse the imposition of a new era of tighter control of financial institutions by individual governments.

The meeting begins with a working dinner hosted by Brown tomorrow night, followed by formal discussions on Thursday.

The G20 has its work cut out for them. According to the latest IMF forecast, global activity is expected to decline by around ½ to 1 percent in 2009 on an annual average basis, before recovering gradually in the course of 2010:

Turning around global growth will depend critically on more concerted policy actions to stabilize financial conditions as well as sustained strong policy support to bolster demand.

  • Restoring confidence is key to resolving the crisis, and this calls for tackling head-on problems in the financial sector. Policymakers must resolve urgently balance sheet uncertainty by dealing aggressively with distressed assets and recapitalizing viable institutions.
  • Since financial market strains are global, greater international policy cooperation is crucial for restoring market trust. Monetary policy should be eased further by reducing policy rates where possible, and supporting credit creation more directly.

Delays in implementing comprehensive policies to stabilize financial conditions would result in a further intensification of the negative feedback loops between the real economy and the financial system, leading to an even deeper and prolonged recession.

Two additional issues will have a significant impact on the outlook: the effectiveness of the fiscal policy response to the crisis; and external financing risks and banking sector vulnerabilities in emerging economies.

The G20 needs to unite and tackle the most serious global economic slowdown in post-war history. In doing so, it needs to consider ways it can curb the negative effects of Casino Capitalism on the real economy and on retirement plans.

On October 10th, 2008, I asked whether the G7 will prevent Dow 3600. So far, it looks as if that disaster was averted.

But we are not out of the woods yet. The leaders of the G20 need to reconcile their differences, fight mounting protectionism, and come up with a coordinated response to this global crisis.

As the masses gather in London to march and protest, there is a global awakening happening across the world. People are fed up with the way politicians have handled this crisis, pandering to the financial oligarchy.

Finally, take the time to read Michael Hudson's latest counterpunch article, Financing the Empire. I quote the following:

The financial oligarchy’s idea of “regulation” is to make sure that deregulators are installed in the key positions and given only a minimal skeleton staff and little funding. Despite Alan Greenspan’s announcement that he has come to see the light and realizes that self-regulation doesn’t work, the Treasury is still run by a Wall Street official and the Fed is run by a lobbyist for Wall Street. To lobbyists the real concern isn’t ideology as such – it’s naked self-interest for their clients. They may seek out well-meaning fools, especially prestigious figures from academia. But these are only front men, headed as they are by the followers of Milton Friedman at the University of Chicago. Such individuals are put in place as “gate-keepers” of the major academic journals to keep out ideas that do not well serve the financial lobbyists.

This pretence for excluding government from meaningful regulation is that finance is so technical that only someone from the financial “industry” is capable of regulating it. To add insult to injury, the additional counter-intuitive claim is made that a hallmark of democracy is to make the central bank “independent” of elected government. In reality, of course, that is just the opposite of democracy. Finance is the crux of the economic system. If it is not regulated democratically in the public interest, then it is “free” to be captured by special interests. So this becomes the oligarchic definition of “market freedom.”

The danger is that governments will let the financial sector determine how “regulation” will be applied. Special interests seek to make money from the economy, and the financial sector does this in an extractive way. That is its marketing plan. Finance today is acting in a way that de-industrializes economies, not builds them up. The “plan” is austerity for labor, industry and all sectors outside of finance, as in the IMF programs imposed on hapless Third World debtor countries. The experience of Iceland, Latvia and other “financialized” economies should be examined as object lessons, if only because they top the World Bank’s ranking of countries in terms of the “ease of doing business.”

The only meaningful regulation can come from outside the financial sector. Otherwise, countries will suffer what the Japanese call “descent from heaven”: regulators are selected from the ranks of bankers and their “useful idiots.” Upon retiring from government they return to the financial sector to receive lucrative jobs, “speaking engagements” and kindred paybacks. Knowing this, they regulate in favor of financial special interests, not that of the public at large.

The problem of speculative capital movements goes beyond drawing up a set of specific regulations. It concerns the scope of national government power. The International Monetary Fund’s Articles of Agreement prevent countries from restoring the “dual exchange rate” systems that many retained down through the 1950s and even into the ‘60s. It was widespread practice for countries to have one exchange rate for goods and services (sometimes various exchange rates for different import and export categories) and another for “capital movements.” Under American pressure, the IMF enforced the pretence that there is an “equilibrium” rate that just happens to be the same for goods and services as it is for capital movements. Governments that did not buy into this ideology were excluded from membership in the IMF and World Bank – or were overthrown.

The implication today is that the only way a nation can block capital movements is to withdraw from the IMF, the World Bank and the World Trade Organization (WTO). For the first time since the 1950s this looks like a real possibility, thanks to worldwide awareness of how the U.S. economy is glutting the global economy with surplus “paper” dollars – and U.S. intransigence at stopping its free ride. From the U.S. vantage point, this is nothing less than an attempt to curtail its international military program.

Michael has written a series of excellent articles on the financial crisis and it's too bad none of the G20 pea brains read any of them. I also doubt they are aware of the pension crisis threatening public finances across the world.

I remain deeply skeptical that the leaders of the G20 will come up with any serious solutions to this global financial crisis. The masses will march and protest in vain as their voices will not be heard.

Who knows, if they're lucky, they might get to hear another live concert by Coldplay (see video below). That might help distract them till the next G20 meeting where they'll be fed more empty promises.

Monday, March 30, 2009

A Giant Experiment?




There is a lot to cover today, so let's begin with U.S. automakers. President Obama gave General Motors and Chrysler deadlines to “fundamentally restructure” or lose government aid that has kept them alive. The steps to force a restructuring by U.S. automakers drew a mixed reaction from members of Congress.

In rejecting the "viability plans" submitted by the struggling automakers, the U.S. government put both the companies and their stakeholders on notice that government-mandated bankruptcy is very much a possibility:

Highlights of the administration's action include:

  • Forced the resignation of longtime GM CEO Rick Wagoner. (My Note: Wagoner walks away with a $20 million retirement package while the rest of GM employees get a pension fund running on fumes.)
  • Gave GM 60 days to present new cost-cutting plans and will provide funds to keep it afloat until that time. "The administration is prepared to stand by GM throughout this process to ensure that GM emerges with a fresh start and a promising future," the White House said, The Wall Street Journal reports.
  • Gave Chrysler 30 days to complete a pending transaction with Fiat, reduce debt and restructure its healthcare obligations. The government's auto task force "doesn't believe Chrysler is viable as a standalone company," according to The Journal.
  • The government will guarantee warranties on all new GM and Chrysler cars; the warranties will lapse back to the automakers once they reemerge from this process (assuming they do).

This may just be a negotiating ploy by the government to get all parties to make major concessions in short order, but the sharp reaction in both stock and bond markets suggests traders see this as more than just a bluff.

Curiously, one major stakeholder which hasn't been asked to make any major concessions yet is Cerberus Capital Management, which controls 80.1% of Chrysler and 51% of GMAC. The private equity firm counts former high-ranking government officials John Snow and Dan Quayle among its board members, and had about $27 billion of capital under management as of December 2008.

Is it really curious that Cerberus Capital Management hasn't been asked to make any major concessions? Not really; they get all upside if the restructuring goes through and taxpayers will protect their downside if things go wrong. Welcome to Capitalism II.

Reuters reports that private equity and hedge funds are concerned about the proposed rules that threaten their secretive industry:
For years, U.S. hedge fund managers have worried that their loosely regulated and secretive industry would one day face tougher regulations.

Now that day seems to be here.

"It was inevitable that this would happen," said Brad Alford, founder of Alpha Capital Management, an advisory firm that invests in hedge funds. "From the time Congress had the industry's top hedge fund managers testify late last year, we knew something was coming."

But exactly what that something will be remains unclear, said managers, their lawyers and investors on Thursday hours after the Obama administration said it plans to press for broad reforms to curb risk taking on Wall Street.

"People want a road map and some clarity," Alford said.

All agreed that putting hedge funds on a tighter leash will add new nervousness to an industry already facing poor returns, struggling with redemptions and being blamed for a financial crisis its managers say they did not cause.

Specifically, many hedge fund managers and their lawyers fear that public outrage over enormous bonuses paid to executives at nearly failed American International Group plus news of hefty paychecks at hedge fund firms could prompt lawmakers to try to impose unduly harsh rules.

"There is a concern that you will end up with ill-fitting regulations," said Elizabeth Shea Fries, who works with hedge funds as a partner at law firm Goodwin Procter.

The private equity industry also voiced concern, saying the proposal "for the first time would impose potentially significant regulation on the private equity industry."

"We believe that private equity investments do not create systemic risk," Douglas Lowenstein, president of industry group the Private Equity Council, said in a statement.

"Private equity firms invest in companies, not exotic securities, and their investors are long-term investors, eliminating the 'run on the bank' type of risk that helped create the current financial crisis," said Lowenstein.

He said the PEC aims to work with the government to ensure that any legislation enacted wouldn't impose "undue burdens on private equity firms."

Undue burden on PE firms? Give me a break! These guys schmooze with Washington's top brass, pass laws to help them mitigate their fair tax bills and then claim that they did not contribute to systemic risk? This is laughable given all the leverage they used to rack up "profits" in their multi-billion dollar buyout funds.

Moreover, as top hedge fund earners take home billions, an astute observer notes that hedge fund inequity is going unnoticed:

Congress has been grandstanding the past weeks in its usual windy style regarding the compensation paid to AIG executives. Amazingly careless confiscatory special tax bills were designed and placed in the legislative hoppers in a matter of days.

Why will Congress not seriously and hastily deal with one of the most unfair and obviously flawed sections of the Internal Revenue Code: the ability of hedge fund managers to pretend that their compensation is really capital gain that should be taxed at 15 percent while the rest of us have our compensation or business profits taxed above 35 percent?

I can't imagine that it would have anything to do with political contributions flowing to Washington from politically active hedge fund managers like George Soros, who made $1.1 billion in 2008, largely by betting against the US dollar. I suppose that the favorable tax rates are due to the enormous value these hedge fund managers add to our national productivity and wealth! I don't know how our country ever grew and prospered before the birth of thousands of hedge funds in the late 1980s.

Perhaps this is why the proposed new rules worry hedge fund and private equity. For so long, they were able to borrow cheaply, leverage up to wazoo, market this as "alpha" and collect huge fees for what was essentially "beta on steroids".

Total nonsense. One senior pension industry insider wrote me tonight, telling me the following:

"Just read an interesting statistic that 37% of all private equity capital raised over the last 30 years was raised in the last three years. A giant experiment whose results won't be known for another 5 to 10 years."
A scary thought indeed, and he is absolutely right, we simply do not know how all these billions of dollars into hedge funds, private equity and real estate funds will pan out over the next decade.

Turbulent financial markets have caused institutional investors to reduce hedge fund exposure temporarily, but not permanently, according to State Street Corp.’s fifth institutional investor hedge fund study:

The study, conducted late last year in conjunction with the 2008 Global Absolute Return Congress, polled representatives from public and government pensions, corporate pensions, endowments and foundations and insurance companies with an estimated $1 trillion in total investable assets.

It found a moderate decline in overall portfolio allocations to hedge funds, but revealed that nearly 90% of institutions intend to increase or maintain current hedge fund allocations over the next 12 months.

“Hedge funds have not been immune to the extremely volatile market environment,” said Gary Enos, executive vice-president and head of relationship management and client strategy for State Street’s alternative investment solutions team. “While alternative investments, including hedge funds, largely outperformed traditional investments in 2008, negative returns understandably disappointed. Although hedge fund allocations declined slightly over the past year, we anticipate growth will resume later in 2009, as institutional investors continue to focus on diversification and risk management.”

The hedge fund study shows that the proportion of institutions allocating more than 5% of their portfolio to hedge funds fell from 68% in 2007 to 51% in 2008.

But 49% of institutions said they would increase their allocation to hedge funds in the next year, and 39% will maintain their current allocation. Of the funding for new hedge fund positions, 80% is expected to come from equity allocations. The study also found increased institutional interest in private equity funds. More than half of institutions have allocated more than 5% of their portfolio to private equity funds, and half intend to increase their allocation to private equity over the next 12 months.

Among the challenges arising from the recent market volatility has been the growing difficulty in accurately valuing derivatives and other complex financial instruments. As a result, 77% of institutions reported that accurately valuing hedge fund holdings can be problematic, up from 55% last year.

The study participants expressed a need for more transparency. Of the institutions, 84% expect more disclosure of hedge fund positions and 49% anticipate more frequent reporting from hedge fund managers. Only 19% said they currently receive some level of consistent transparency across hedge fund holdings.

To gain a more meaningful assessment of risk across their portfolio, nearly two-thirds of institutional investors either intend to, or already are, aggregating alternative investment risk exposures with other portfolio exposures.

“The recent unprecedented market volatility has prompted institutions to increase their focus on risk management,” said Enos. “To address these concerns and the increasingly difficult challenges inherent in the financial markets, the hedge fund community and allied third-party providers and administrators are stepping up efforts to develop and expand risk management solutions for institutional investors.”
Expand risk management solutions? What is that some euphemism or hedgespeak for trying to pull the wool over our clients' eyes? When are people going to wake up and finally realize that the majority of hedge funds are selling beta as alpha? (Note: Bloomberg reports that hedge funds are using emerging-market exchange-traded funds “quickly raise risk levels”. And why are they charging 2 & 20 for this "alpha"?!?)

After getting clobbered in 2008, some large pension funds are now taking a tougher stance. CalPERS is now playing hard ball with hedge funds, demanding changes:

The nation’s largest public pension fund is not happy with hedge funds, and it’s not going to take it anymore.

The California Public Employees’ Retirement System issued a stern warning to the asset class, in which it is a large and pioneering investor. The $173 billion pension said it plans to demand greater transparency and greater control of its assets invested with hedge funds.

“In recent years, institutional investors have displaced wealthy individuals as the main clients of hedge funds,” CalPERS said in a statement. “However, the hedge fund marketplace has not evolved sufficiently to accommodate what institutional investors require to maximize long-term benefits for their beneficiaries.”

Among the pension’s plans to “restructure” its hedge fund investments are more investments in managed accounts and other customized vehicles, as well as pushing hedge funds it invests with to reshape their fee system to focus more on long-term performance by spreading fees out rather than charging them annually. CalPERS also wants more clawback provisions, allowing investors to recoup some fees when performance takes a dive.

“We believe that investors and managers alike stand to benefit over the long-term when interests are better aligned, asset controls are properly instituted and transparency of risks and exposures is improved.”

CalPERS made its demands in a March 11 memo sent to 26 hedge funds and nine funds of funds it invests with, The Wall Street Journal reports. Among those counting CalPERS as a client are such luminaries as Atticus Capital, Och-Ziff Capital Management and Tremblant Capital.

The pension called the desired changes “extremely important,” and warned that it would “no longer invest in managers” that ignored them.

It's about time CalPERS wakes up and stops being the 800-pound monkey that shoves billions into hundreds of alternative investment funds.

Tyler Durden of Zero Hedge blog wrote all about CaliPERSnication this past Saturday. I quote the following:

Two years ago it was said that you if had a direct line to the CIO of CalPERS, one of the nation's largest public pension funds, and specifically to its Alternative Investment Management group, you had it made. None of that Goldman Sachs partners being masters of the universe garbage - this was the real deal. Say you needed $100 million for fund XYZ - you simply dialed that one number in Sacramento, and if you made it past the secretary, you were golden.

Of course, this worked best if your name started with Leon and ended with Black, but other managers were also sitting pretty. The reason for this is that unlike the public pension funds of New York State for example, where the bulk of the investments were in the public markets via an internal asset manager (who was pretty horrible at his job judging by the fund IRR), and only occasionally did NY invest in external private and public fund managers (which more often than not included a variety of kickbacks, bribes, and other illegal schemes as recently reported by NY's own Andrew Cuomo), CalPERS has the bulk of its assets invested in 3rd parties.

While Thomson Banker gives the total amount of CalPERS public investments at $38 billion, an obscure site within the CalPERS website labyrinth presents the amount allocated and invested in various 3rd parties. And the amount is staggering: it seems that a vast number, maybe even a majority of U.S. private equity firms, owe their existence to CalPERS.

Tyler goes on to analyze some of the IRRs reported by CalPERS AIM and concludes:

We highly doubt -10.7% is anything even remotely close to where CalPERS should consider its residual equity value in Apollo VI. And by fair estimates, this is merely the tip of the iceberg. Nonetheless, presenting public data that shows that the public pensions manager is disclosing over $14 billion in profits when it is hiding potentially much more than that in losses could be interpreted as borderline illegal. The question is, is this a responsibility of Apollo (to show the true sad state of affairs), or of CalPERS (to actually check these numbers and not to pull a Fairfield Greenwich "sorry, we had no clue what was really going on until it was too late").

Regardless, as CalPERS itself points out, the numbers were as of September 30. It is a fact, that the December 31 numbers are due any minutes and we are salivating at the prospect of feasting out eyes on these numbers, to see just how much disconnected from reality the column known as IRR as presented by CalPERS has become. And just as Apollo VI is merely the tip of the asset manager iceberg, so is CalPERS merely a blip in the Alternative Investment Management universe of all public pension managers. Combined together, and based on realistic performance, these two will result in an explosive deterioration in both fund IRRs and public pensioners' patience and empathy, once they realize their money has been mismanaged into oblivion.
Note my comment at the end of that post. The bursting of the alternative investment bubble will expose the true value of many of these investments.

But hold on just a minute. A buddy of mine sent me a Bloomberg article that proposed changes to mark-to-market rules are about to go into effect:

Four days after U.S. lawmakers berated Financial Accounting Standards Board Chairman Robert Herz and threatened to take rulemaking out of his hands, FASB proposed an overhaul of fair-value accounting that may improve profits at banks such as Citigroup Inc. by more than 20 percent.

The changes proposed on March 16 to fair-value, also known as mark-to-market accounting, would allow companies to use “significant judgment” in valuing assets and reduce the amount of writedowns they must take on so-called impaired investments, including mortgage-backed securities. A final vote on the resolutions, which would apply to first-quarter financial statements, is scheduled for April 2.

FASB’s acquiescence followed lobbying efforts by the U.S. Chamber of Commerce, the American Bankers Association and companies ranging from Bank of New York Mellon Corp., the world’s largest custodian of financial assets, to community lender Brentwood Bank in Pennsylvania. Former regulators and accounting analysts say the new rules would hurt investors who need more transparency, not less, in financial statements.

Officials at Norwalk, Connecticut-based FASB were under “tremendous pressure” and “more or less eviscerated mark-to- market accounting,” said Robert Willens, a former managing director at Lehman Brothers Holdings Inc. who runs his own tax and accounting advisory firm in New York. “I’d say there was a pretty close cause and effect.”

Willens, investor-advocate groups including the CFA Institute in Charlottesville, Virginia, and former U.S. Securities and Exchange Commission Chairman Arthur Levitt oppose changes that would enable banks to put off reporting losses.

‘Outrageous Threats’

“What disturbs me most about the FASB action is they appear to be bowing to outrageous threats from members of Congress who are beholden to corporate supporters,” said Levitt, now a senior adviser at buyout firm Carlyle Group and a board member at Bloomberg LP, the parent of Bloomberg News.

FASB spokesman Neal McGarity said the proposal allowing significant judgment was “in the works prior to the Washington hearing and was merely accelerated for the first quarter, instead of the second quarter.” The plan on impaired investments “was an attempt to address an important financial reporting issue that has emerged from the financial crisis,” he said.

I guarantee you that private equity funds were lobbying hard to change mark-to-market rules, enabling them to "fudge" their numbers going forward. In the pension world, they call this "alpha".

This brings me to my concluding thoughts. In late January, Pensions & Investments published an article, PBGC Premium Boost. I quote the following:

The agency’s huge deficit and Mr. Millard’s desire to avoid any eventual PBGC taxpayer bailout spurred the most significant contribution during his tenure: a major change in the agency’s asset allocation policy in February 2008 that permits the agency to invest up to 10% of the $55 billion it has available in private equity and real estate. Both are new asset classes for the PBGC.

Under the new asset allocation, designed to close the PBGC’s deficit over the next 10 to 20 years, 45% of assets will be in equities, 45% in fixed income and 10% in alternatives. Previously, 75% to 85% was in fixed income in a strategy designed to match assets with liabilities. The remainder was invested in stocks.

Some critics have charged the new asset allocation is too aggressive for an agency that is supposed to backstop failed private pension plans. But Mr. Millard said the new policy has a far better chance of closing the PBGC deficit than the previous policy did.

“I would urge people to recognize that it is a long-term policy, and that PBGC’s liabilities will last for decades, and we need an investment policy that focuses on the long term,” Mr. Millard said.

Today, the Boston Globe reports that the pension insurer shifted to stocks:

Just months before the start of last year's stock market collapse, the federal agency that insures the retirement funds of 44 million Americans departed from its conservative investment strategy and decided to put much of its $64 billion insurance fund into stocks.

Switching from a heavy reliance on bonds, the Pension Benefit Guaranty Corporation decided to pour billions of dollars into speculative investments such as stocks in emerging foreign markets, real estate, and private equity funds.

The agency refused to say how much of the new investment strategy has been implemented or how the fund has fared during the downturn. The agency would only say that its fund was down 6.5 percent - and all of its stock-related investments were down 23 percent - as of last Sept. 30, the end of its fiscal year. But that was before most of the recent stock market decline and just before the investment switch was scheduled to begin in earnest.

No statistics on the fund's subsequent performance were released.

Nonetheless, analysts expressed concern that large portions of the trust fund might have been lost at a time when many private pension plans are suffering major losses. The guarantee fund would be the only way to cover the plans if their companies go into bankruptcy.

"The truth is, this could be huge," said Zvi Bodie, a Boston University finance professor who in 2002 advised the agency to rely almost entirely on bonds. "This has the potential to be another several hundred billion dollars. If the auto companies go under, they have huge unfunded liabilities" in pension plans that would be passed on to the agency.

In addition, Peter Orszag, head of the White House Office of Management and Budget, has "serious concerns" about the agency, according to an Obama administration spokesman.

Last year, as director of the Congressional Budget Office, Orszag expressed alarm that the agency was "investing a greater share of its assets in risky securities," which he said would make it "more likely to experience a decline in the value of its portfolio during an economic downturn the point at which it is most likely to have to assume responsibility for a larger number of underfunded pension plans."

However, Charles E.F. Millard, the former agency director who implemented the strategy until the Bush administration departed on Jan. 20, dismissed such concerns. Millard, a former managing director of Lehman Brothers, said flatly that "the new investment policy is not riskier than the old one."

He said the previous strategy of relying mostly on bonds would never garner enough money to eliminate the agency's deficit. "The prior policy virtually guaranteed that some day a multibillion-dollar bailout would be required from Congress," Millard said.

He said he believed the new policy - which includes such potentially higher-growth investments as foreign stocks and private real estate - would lessen, but not eliminate, the possibility that a bailout is needed.

Asked whether the strategy was a mistake, given the subsequent declines in stocks and real estate, Millard said, "Ask me in 20 years. The question is whether policymakers will have the fortitude to stick with it."

But Bodie, the BU professor who advised the agency, questioned why a government entity that is supposed to be insuring pension funds should be investing in stocks and real estate at all. Bodie once likened the agency's strategy to a company that insures against hurricane damage and then invests the premiums in beachfront property.

Since he issued that warning, he said, the agency has gone even more aggressively into stocks, which he called "totally crazy."

The agency's action has also been questioned by the Government Accountability Office, the investigative arm of Congress, which concluded that the strategy "will likely carry more risk" than projected by the agency. "We felt they weren't acknowledging the increased risk," said Barbara D. Bovbjerg, the GAO's director of Education, Workforce and Income Security Issues.

Analysts also believe the strategy would not have been approved if the government had foreseen the precipitous decline in the stock market.

Now, they warn about a "perfect storm" scenario in which the agency's fund plummets in value just as more companies go into bankruptcy and pass their pension responsibilities onto the insurance fund. Many analysts say it is inevitable that the agency will face significantly increased liabilities in coming months.

"The worst case scenario is coming to pass," said Mark Ruloff, a fellow at the Pension Finance Institute, an independent group that monitors pensions. He said the agency leaders "fail to realize that they are an insurer of pension plans and therefore should be investing differently than the risk their participants are taking."

The Pension Benefit Guaranty Corporation may be little-known to most Americans, but it serves as a lifeline for the 1.3 million people who receive retirement checks from it, and the 44 million others whose plans are backed by the agency.

The agency was set up in 1974 out of concern that workers who had pensions at financially troubled or bankrupt companies would lose their retirement funds. The agency operates by assessing premiums on the private pension plans that they insure. It insures up to $54,000 annually for individuals who retire at 65.

Despite its name, the agency does not necessarily guarantee the full value of a person's pension and is not backed by the full faith and credit of the government.

Nonetheless, agency officials say that if the pension agency fails to meet its obligation, the government would come under intense political pressure to step in. That means taxpayers - including those who don't get pensions - could be asked to pay for a bailout.

Currently, the agency owes more in pension obligations than it has in funds, with an $11 billion shortfall as of last Sept. 30. Moreover, the agency might soon be responsible for many more pension plans.

Most of the nation's private pension plans suffered major losses in 2008 and, all together, are underfunded by as much as $500 billion, according to Bodie and other analysts. A wave of bankruptcies could mean that the agency would be left to cover more pensions than it could afford.

In the early years of the George W. Bush presidency, the agency took a conservative investment approach under director Bradley N. Belt, who favored putting only between 15 and 25 percent of the fund into stocks.

Belt said in an interview that he operated under "a more prudent risk management" style and said he "would have maintained the investment strategy we had in place." Belt left in 2006 and Millard arrived in 2007.

Under Millard's strategy, the pension agency was directed to invest 55 percent of its funds in stocks and real estate. That included 20 percent in US stocks, 19 percent in foreign stocks, 6 percent in what the agency's records term "emerging market" stocks, 5 percent in private real estate and 5 percent in private equity firms.

Millard said he thought he had little choice but to seek a higher investment return in part because Congress had limited the agency's ability to charge higher premiums based on each plan's likelihood of drawing on the agency's funds.

The agency's board - which consists of the secretaries of Treasury, Labor, and Commerce - approved the new investment strategy in a meeting in February 2008. But the board members have had only a limited role in the agency's operation, meeting only 20 times over the 28 years before 2008.

The board is also too small to meet basic standards of corporate governance, according to an analysis by the Government Accountability Office.

"The whole model of having three sitting Cabinet secretaries with day jobs overseeing a $60 billion investment portfolio and occasionally owning significant percentages of large American companies is fundamentally flawed," said Belt, the former agency director.

The Government Accountability Office is preparing a new review of the investment policy, but in the meantime it continues to place the agency on its list of federal programs at "high risk."

And the article above brings me to another excellent post by Ian Williams that appeared on the Barricade blog over the weekend, Who Killed U.S. Public Pension System?

Ian was kind enough to email me and share his insights with me. The charts above are from his post and I quote the following:

Professor and Nobel Laureate Paul Samuelson in late 1998 was quoted as saying, a bit sadly, “I have students of mine - PhDs - going around the country telling people it’s a sure thing to be 100% invested in equities, if only you will sit out the temporary declines. It makes me cringe.”

When someone tells you that stocks always beat bonds, or that stocks go up in the long run, they have not done their homework. At best, they are parroting bad research that makes their case, or they are simply trying to sell you something.

Which leads nicely into our 2nd bullet point - politically connected pension systems promising benefits and COLA’s assuming and I am likely being conservative a 7.5% investment return assumption on their portfolio which is now skewed heavily into stocks over bonds. Their investment return assumptions are PIE IN THE SKY or RAINBOW PONIES WITH WINGS depending which fantasy reference you prefer. I think it is time for pension systems to allocate 200% into equities with leverage provided by the US Govt as the retirement and pension systems are woefully underfunded.

The misleading numbers posted by retirement fund administrators help mask this reality: Public pensions in the U.S. had total liabilities of $2.9 trillion as of Dec. 16, according to the Center for Retirement Research at Boston College. Their total assets are about 30 percent less than that, at $2 trillion. With stock market losses this year, public pensions in the U.S. are now underfunded by more than $1 trillion.

I urge to read Ian's entire post and to start taking a closer look at how your pension funds are being managed or mismanaged.

The solution to the pension crisis won't be easy. But we have to start by admitting that the crisis exists and that pension funds have not taken adequate steps to address their underfunded status. Only then will we be in a better position to confront the challenges that lie ahead.

Sunday, March 29, 2009

Blame it on the Gipper?


Before getting into this weekend's food for thought topic, I think you should all watch Secretary of the Treasury Tim Geithner's interview on ABC's This Week and the roundtable discussion where Paul Krugman expressed his concerns with the plan.

Interestingly, Krugman thinks the U.S. government is not doing enough to combat the crisis and that the plan will lead to another Japanese-style lost decade. I agree and I also agree that deficits do not matter in times of crisis because if you don't get the economy working again, the deficits will only get worse in the future.

But I want to take a step back this weekend and look at the historical events that laid the foundation to this global crisis. On Friday morning, I listened to an excellent interview on CBC Radio's The Current with Bill Kleinknecht, author of the new book, The Man Who Sold The World: Ronald Reagan and the Betrayal of Main Street America.

Ever since the global economic crisis took hold, people have been looking for a place to park the blame for it. Over-extended homeowners. Greedy bankers. Lackluster regulators. Inept elected officials.

Mr. Kleinknecht has another idea. He says the roots of this crisis go all the way back to the early 1980s and land at the feet of U.S. President Ronald Reagan. Click here to listen to the interview (scroll down to part 3).

Here is a review from Joe Conason published in BuzzFlash Reviews:
From the Nation:

The myth of Ronald Reagan's greatness has reached epic proportions. The public rates him as one of the most popular presidents, and Republicans everywhere seek to cast themselves in his image. But award-winning journalist William Kleinknecht shows in this penetrating analysis of his presidency that the Reagan legacy has been devastating for the country—especially for the ordinary Americans he claimed to represent.

So much that has gone wrong in America—including the subprime mortgage crisis and the meltdown of the financial sector—can be traced directly to Reagan's policies. The financial deregulation launched in the 1980s freed banks and securities firms to squander hundreds of billions of dollars and make a shambles of the economy.

Boom-and-bust cycles, obscene CEO salaries, blackouts, drug-company scandals, collapsing bridges, plummeting wages for working people, the flight of U.S. manufacturing abroad—these are all products of Reagan's free-market zealotry and his gutting of the public sector. Reagan pioneered the use of wedge issues like race and the war on drugs to distract America while his administration empowered corporations to lay waste to our traditional ways of life.

In the spirit of Thomas Frank's What's the Matter with Kansas?, Kleinknecht takes us to Reagan's hometown of Dixon, Illinois, to show that he was anything but a friend to Main Street America. Relying on detailed factual analysis rather than opinion, The Man Who Sold the World is the first major work to explode the Reagan myth.

This book is a great companion to Will Bunch's Tear Down This Myth: How the Reagan Legacy Has Distorted Our Politics and Haunts Our Future (Hardcover)

"A seasoned crime reporter of the old school, William Kleinknecht has penetrated the showbiz curtain to expose the venality and cynicism of the Reagan era—and tells us why the crimes of that time still matter so much today."

So should we blame this mess on the Gipper? It's easy to blame a dead president for laying the foundations of today's global financial crisis, but there are many other figures from both political parties that followed the Gipper and cemented this crisis.

I leave you with another Go Left radio interview with Bill Kleinknecht (two parts; click below to listen). As you listen, keep in mind that it is important to remember the historical context of this global financial mess and the ideological undertones that played a role in shaping our financial markets.

Also, think about the wedge issues that are diverting attention from today's bigger problems, including the fundamental breakdown of our pension system.

Part 1:



Part 2:

Friday, March 27, 2009

And CEOs' Pensions?


A buddy of mine emailed me urging me to write about CEO pensions. So how good are CEO pensions? I found a Forbes article from July 2007 stating that CEO pensions continue to soar:

Maybe "pension" isn't the right word anymore to call what the world's top bosses are raking in after they call it quits. "Incentive" is more like it.

The latest example: "Ma Bell" boss Edward Whitacre, 65, widely acknowledged as a revolutionary in the telecommunications business, will be handsomely compensated for his 43 years of service at AT&T.

His total package is a reported $161 million. But is he, or any of these oft-vaunted executives, worth it?

Paul Hodgson, senior research associate at the Corporate Library, believes such an award isn't warranted, considering that Whitacre, whose last day on the job is June 3, has already been paid his fair share for working the past four-plus decades for the same company.

"They've been paying him salary, bonuses and long-term incentives for the 43 years he's been there," Hodgson said. "What is his pension for? As far as I know, the pension is to give you some financial security when you're finished working. It's not an incentive.

"I don't even think it [the pension] should be there, to be honest. Not at that level," Hodgson said.

Whitacre will receive the third-highest retirement package in U.S. corporate history, behind former Exxon Mobil chief Lee Raymond, who received $351 million. The majority of that sum consisted of retirement-independent salary, bonuses, stock options and restricted stock awards from Raymond's final year and prior years.

Whitacre is due more than $161.6 million, including $73.8 million in deferred compensation and $84.7 million in a pension plan. He'll also make more than $1 million per year for three years as a consultant for the company, according to AT&T's proxy statement.

Bill Coleman, senior vice president of compensation at Salary.com, said the modern method of disclosure puts the entire pension amount in one lump sum when it is reported, as opposed to how it will be dispensed over time, which is why shareholders'--and the public's--jaws tend to drop.

Coleman said there is some uniformity in the way companies calculate pensions, excluding other compensation and perks. Typically, the bean counters take 60% of the employee's final salary, while taking into account the highest bonuses he or she received within the last five years, which may or may not have been directly related to performance.

The information is publicly available to shareholders who feel like doing the math. Most don't, and that's why people behave as if they have been blindsided by bloated pensions.

From there, each company has its own methods of compensation based on contracts and board approvals for any additional perks.

That's when it can start soaring to heights most people can't fathom, outside of winning the lottery, unless they're the Whitacres of the world, who expect to maintain their pre-retirement lifestyles.

"There's really no difference between $20 million and $200 million to most people," Coleman said. "Even for your average reader, from where they're sitting, those are basically the same numbers, because it's so much more than the average American has.

"As you get closer to $20 million or $200 million, then you start seeing the difference between the two points," Coleman said.

But at least Whitacre spent more than four decades with the same company, and pensions, if nothing else, are supposed to reflect corporate loyalty. Yet there have been cases where executives spent just a short time at a company before retirement but have walked away with huge packages.

Hodgson said certain companies are reconsidering these overweight pensions in favor of more "modest and sensible" packages, a practice that he hopes will become more widespread.

"Some [boards] might make it a little more difficult to hand over money just willy-nilly without relating it to performance," he said. "But there are a bunch of executives out there who will say, "Oh no, that's in my contract, and that's what I get."

On Thursday, Bloomberg reported that JP Morgan will delay contributions to employees’ 401(k) plans:

JPMorgan Chase & Co. will delay contributions to 401(k) retirement plans for salaried employees until the end of the year and may reduce the payments, according to a person who received a company memo on the changes.

Workers making $50,000 to $250,000 annually will cease getting the contributions every two weeks and may see the benefits adjusted to a yet-to-be-decided amount, according to the person, who declined to be identified because the New York- based bank hasn’t disclosed the new policy. The dollar-to-dollar match for those earning less than $50,000 won’t change, the person said.

JPMorgan, which is the biggest U.S. bank by deposits and has a global workforce of about 200,000, doesn’t contribute to retirement plans of employees with annual salaries of more than $250,000.

“JPMorgan is using this period to tighten up all of if its costs structures right across the board,” said Richard Bove, an analyst at Rochdale Securities in Lutz, Florida. Chief Executive Officer Jamie Dimon is “just battening down the hatches.”

JPMorgan spokesman Brian Marchiony declined to comment.

U.S. companies are cutting back matching contributions to employee retirement plans to save cash, and the trend is growing, according to a survey by Spectrem Group. The survey of 150 U.S. companies found that 34 percent have reduced or eliminated retirement-plan contributions since January 2008. In the next 12 months, 29 percent intend to scale back or eliminate their match, the survey showed.

At least 148 U.S. employers have stopped or reduced 401(k) matching contributions since June 2008, including General Motors Corp., Eastman Kodak Co., Motorola Inc., Sears Holdings Corp. Hewlett-Packard Co. and Xerox Corp., according to the Pension Rights Center, which is pushing for retirement savings alternatives to the 401(k).

As U.S. companies cut back matching contributions to employee retirement plans, I wonder how many CEOs are also cutting back their perks.

Here in Canada, the Globe & Mail reports that Michael Sabia is giving up his pension, two years of bonuses and any future golden handshake from the Caisse de dépôt et placement du Québec after mounting controversy over his appointment as chief of the huge pension fund:

Mr. Sabia, former chief of BCE Inc., told Caisse chairman Robert Tessier of his intention in a letter Monday when he indicated he was relinquishing his right to any bonuses for the first two years of his tenure "regardless of the results" the fund may achieve.

Mr. Sabia also turned down the $235,000-a-year pension, an amount recently approved by Quebec Premier Jean Charest's cabinet.

And in the event Mr. Sabia should be fired, regardless of the reasons, the newly appointed Caisse chief said he would refuse whatever amount he would be entitled to on leaving the position.

Mr. Sabia's pension was the target of criticism from opposition parties. Mr. Sabia wrote to Quebec Finance Minister Monique Jérôme-Forget authorizing her yesterday to release the letter sent to Mr. Tessier.

Mr. Sabia's appointment two weeks ago has drawn criticism over how it was done.

Former Quebec premier Jacques Parizeau, for example, joined the growing ranks of those who accused the government of imposing Mr. Sabia's nomination without giving serious consideration to other candidates.

Former Caisse board members and prominent business executives have been taking turns publicly questioning the speed of Mr. Sabia's selection as well as what they say are the unusual circumstances of the hiring process.

The appointment came as the Caisse, which holds $120-billion in assets, seeks to repair its tattered reputation after a disastrous 25-per-cent loss for 2008, resulting in part from its huge exposure to the high-risk asset-backed commercial paper market.

Mr. Sabia got the nod only a week after the government appointed Mr. Tessier as chairman, responsible for finding a CEO. Mr. Sabia was also chosen just four days after Mr. Tessier first met with the Caisse board to form a hiring committee.

Mr. Tessier has also come under fire for not meeting with the only other candidate for the CEO job on the short list.

The way Mr. Sabia was seemingly swept into the Caisse's corner office drew fire from opposition politicians who alleged the pension fund's board simply rubber-stamped the hand-picked choice of Mr. Charest's government.

"I think the process respected the letter of the law but not the spirit," Yvan Allaire, a former Caisse director, said yesterday.

"It seems like a lot to have achieved in one week," said Mr. Allaire, who was a board member until shortly before Mr. Sabia's appointment on March 13, when his mandate was not renewed by the government. "I'm not questioning the idea that Mr. Sabia might be the best candidate for the position," he added.

Claude Garcia, former head of Standard Life Assurance Co. of Canada and a former director, said he also has concerns with the process.

"I agree that this is miraculous," he said about Mr. Sabia's swift clearing of the hiring hurdles. "If I had been there, I would not have proceeded in that way."

Caisse officials were not available to comment yesterday, but Mr. Tessier has said he is satisfied the hiring of Mr. Sabia was handled in a rigorous and correct fashion.

For Serge Saucier, an influential member of Quebec's business community who is retired but still serves as a corporate director, the process appears to have been rushed. "It would seem to me to have been a little unusual. It seems that steps were skipped."

Michel Nadeau, a former Caisse senior executive who is now executive director of the Institute for Governance of Private and Public Organizations, also said the Caisse fumbled the CEO hiring process.

Whenever I read Mr. Nadeau commenting on the Caisse, I take his criticism with a shaker of salt. When he was the number two guy at the Caisse, he ruled it with an iron fist, so his criticism of the hiring process is hypocritical.

Was the hiring process open and transparent? Of course not. Although I can't prove it, my hunch is that Quebec Premier Jean Charest was fed up with the shenanigans at the 'Basket Caisse' and he wanted someone to clean up the shop.

The hiring of the Caisse's leader has always been politically motivated. This is unfortunate but that's the way it has always been.

People are quick to criticize Mr. Sabia, stating that he did a terrible job at Bell Canada, but he's accepted the challenge of his life at the Caisse and at least he isn't there for perks and golden parachutes.

By the way, Mr. Sabia isn't the only one to forgo bonuses. Reuters reports that board members of the two largest Dutch pension fund managers APG and PGGM have agreed to cancel their bonuses for 2008, the fund managers said on Friday:

The board members agreed not to accept bonuses because their clients -- pension funds such as ABP and Zorg & Welzijn -- have been unable to index pensions to inflation this year, and due to the fact they have incurred sharp investment losses, newspaper De Volkskrant reported earlier on Friday.

"It has been decided to put the bonuses on zero for 2008," PGGM spokesman David Uitdenbogaard said. "First of all for the results over 2008."

Uitdenbogaard added that because PGGM's pension fund is unable to index pensions for their members this year, the decision to cancel bonuses was a signal of goodwill to the healthcare sector it represents.

APG spokesman Hans ten Brinke also confirmed that board members of the fund manager had agreed to forgo bonuses.

Newspaper De Volkskrant added that APG and PGGM have previously criticised unclear bonus criteria for executives at the companies they invest in.

Many Dutch pension funds have fallen into deficits due to the credit crisis and are working to file recovery plans with the regulator, the Dutch central bank (DNB), before a deadline of April 1.

Bonuses for the executives of listed financial firms have also come under criticism and the Finance Ministry has said it will seek to curtail bonuses among senior management at financial companies receiving government support.

Finally, Mark DeCambre, Wall Street reporter for The New York Post was on Tech Ticker stating that there actually is some truth to the we have to pay our top people outlandish salaries argument because bonus restrictions will drive talent overseas.

I have heard this argument before. Where are they going to go? I guess they can go to China, build up their securitization market over there and screw up their financial system.

This is all just more glue that binds a nation.

Thursday, March 26, 2009

Will Big Pensions Swallow Smaller Ones?


The CBC reports that Ontario will hit a record $14.1 billion deficit in 2009:

Ontario will rack up a record $14.1-billion deficit in 2009 as it commits billions to infrastructure projects and job retraining aimed at pulling the province out of a recession, provincial Finance Minister Dwight Duncan revealed on Thursday in the tabling of his $108.9-billion budget.

The fiscal plan also proposes corporate tax cuts to ease costs for struggling businesses and stimulate investment in Ontario’s sagging economy, which has shed hundreds of thousands of jobs in recent years.

The budget forecasts a deficit of $3.9 billion in the 2008-2009 fiscal year, followed by a deficit of $14.1 billion in 2009-2010. It anticipates Ontario will run deficits for the next seven years, with a proposed return to balanced books no later than the 2015-2016 fiscal year.

The province and the federal government have also agreed to harmonize the provincial sales tax and GST into a single 13 per cent sales tax by July 1, 2010, which Duncan called the "next essential step" in growing the province's economy and improving competitiveness.

It also allocates a $3.4-billion contingency fund, from which an unspecified amount can be directed toward a bailout package for the province’s beleaguered auto industry once negotiations with automakers are completed.

One proposal that caught my eye was that Ontario may turn its largest pension fund, the Ontario Teachers' Pension Plan (OTPP), into an even bigger entity that could manage money for civil servants, university endowments and other groups:

The province's Liberal government is introducing new legislation that would allow smaller pension plans and “institutional investors in the public sector” to use Teachers to handle their money and administer pensions, for a fee.

The move, contained in the provincial budget Thursday, would give added heft to an organization that is already one of the largest and most influential investors in Canada. Teachers had about $108-billion in assets as of the end of 2007. It will disclose how much that figure declined in 2008 when it unveils its year-end financial results next week.

Allowing other funds to plug into Teachers' investment expertise would lower costs and bring “enhanced investment opportunities for future OTPP clients,” the budget documents say. Teachers would even be permitted to manage pension money for groups outside of Canada.

The government also used budget day to announce or confirm other initiatives to help corporate pension funds hit hard by the turmoil in the financial markets.

Provincially-regulated pension funds will get up to 10 years, in some cases, to make the payments needed to make up a solvency deficit. In the meantime, the government will conduct a study to determine the health of its Pension Benefit Guarantee Fund, which pays some pension benefits when companies go out of business and their pension funds are wound up. The fund had a $102-million deficit as of March 31, 2008.

Queen's Park will also change tax law to allow workers who are at retirement age to begin drawing a pension, yet keep working and accumulating pension credits.

And the budget promises the McGuinty government will work with Ottawa and the other provinces to investigate ways to increase pension coverage. About 80 per cent of private-sector employees in Canada do not have a defined-benefit pension from their employer.

So Ontario Teachers' will get more assets to manage. This isn't a bad idea given that Teachers' has an excellent reputation and it can manage funds better at a lower cost.

But the proposal is sure to raise some eyebrows after Teachers' reports its results next week. As I reported in the past, I expect Teachers' is heading for a fall.

Also, I read that the Ontario Municipal Employees Retirement System (OMERS) wants a piece of the action as big pensions to hold umbrella over smaller ones:

Should the big pension plans in Ontario become an umbrella for smaller pension plans? That appears to be the route the province’s Liberal government would like to see taken.

In its budget, the province is introducing new legislation that would allow smaller pension plans and institutional investors in the public sector the right to hand over their portfolios and the responsibility of administering pensions to the Ontario Teachers’ Pension Plan for a fee.

OTPP, which had $108-billion of assets under management as of Dec. 31, 2007, is the third-largest pension plan in the country.

The benefits would include higher revenue for OTPP, lower administrative costs and "enhanced investment opportunities" for future clients of the fund.

The proposal is consistent with recommendations made by the Ontario Expert Commission on Pensions Report (otherwise known as the Arthurs' Report), released in November, which suggested the cumulative effect of handing over the reins of small funds to larger plans would mean lower investment fees, better in-house investment expertise, and the ability to spread investment risk through diversification.

"We support such a proposed amendment and we commend the government for moving quickly for recognizing and acting on the recommendations of the Arthurs' Report," said Deborah Allan, spokeswoman for OTPP.

While the Ontario government singled out OTPP, Michael Nobrega, president and chief executive of the Ontario Municipal Employees Retirement System (OMERS) has previously stated his support for a consolidation of public pension funds in the province. OMERS already manages pension money for Ryerson University, Transit Windsor and a small plan for Ontario Hydro, and is being approached by others.

"To the extent these opportunities come our way, we'd look favorably at them," Mr. Nobrega told journalists at a press conference last month.

I am sure he would. After taking a drubbing in private equity, OMERS would love to manage more assets so they can place bigger bets in private markets.

You see when it comes to pensions, size matters. You get to brag about how big you are and how great you are. It's all about "pension envy".

But politicians may want to rethink this strategy. If you are going to cover more smaller plans using a bigger plan, you'd better bolster the governance, making sure that the pension managers are not taking excessive risks with the funds they manage.

Finally, if you ask me, neither OTPP nor OMERS should manage these smaller plans. I think HOOPP's results in 2008 and over the past 10 years speak for themselves.

Wednesday, March 25, 2009

Pension Funding Gap Deteriorates in February


Pension funds for companies in Standard & Poor's 1500 Index met 74% of future obligations in February, down from 89% before the market crashed, Bloomberg reports:
The amount by which U.S. pensions are underfunded has almost doubled since October to $373 billion, increasing pressure on companies to give more to retirement plans as the global recession saps earnings.

U.S. retirement plans are able to meet 74 percent of their future obligations, down from 89 percent five months ago, after global stocks fell and contributions were delayed, according to Mercer’s Financial Strategy Group, a Marsh & McLennan Cos. unit. DuPont Co., Caterpillar Inc. and Lockheed Martin Corp. are among the companies that say they expect higher pension costs in 2009 (click on chart above to enlarge).

Last year’s drop in U.S. stock prices, the deepest in seven decades, will saddle the 53 percent of companies in the Standard & Poor’s 1500 Index with defined-benefit plans with about $70 billion in pension expenses this year, a sevenfold increase from 2008, as they seek to close the funding gap, Mercer analyst Adrian Hartshorn said yesterday in an interview.

“Everybody is facing the same problem: big companies, charities, non-profits,” said Judy Schub, managing director of the Bethesda, Maryland-based Committee on Investments of Employee Benefit Assets, whose members’ plans are responsible for more than 11 million workers and retirees. “The call on their cash is going to be significantly higher, two or three times higher, than they had planned.”

Legislation passed last year requires the companies to pay down the shortfalls in seven years, Mercer’s Hartshorn said. Watson Wyatt Worldwide Inc., an Arlington, Virginia-based consulting firm, has analyzed the 100 largest U.S. pension plan sponsors and said some companies are making contributions in advance, anticipating larger future commitments.

DuPont’s Expenses

DuPont’s pension expenses may rise 40 cents to 50 cents a share this year after the plan’s assets fell 28 percent to $16.2 billion, the company said in a Feb. 12 filing. The pension is underfunded by $5.3 billion, compared with a $412 million surplus a year earlier, DuPont said.

The $5.14 billion decline in the value of the plan’s holdings last year won’t change the company’s investment strategy, Valerie Sills, DuPont Capital Management president, said in an interview.

“Equities are very attractive at this point in time,” Sills said. “We’ve always had a healthy equity weighting.”

DuPont, the world’s third-largest chemical maker, plans to increase the amount of equities in its plan to 52 percent this year from 49 percent in 2008, according to its filing. About a third of its portfolio will remain in fixed income, with the remainder divided between real estate and other investments. Equities made up 55 percent of DuPont’s assets in 2007.

Wilmington, Delaware-based DuPont said in a filing it hasn’t determined how much it may contribute to its pensions this year and it isn’t required to add funding to the plan at this time.

Loss, Job Cuts

DuPont in January reported a fourth-quarter loss of $629 million as global demand for materials used in cars and homes deteriorated. The company has cut 2,500 jobs and 8,000 contractor positions.

Lockheed Martin, the nation’s largest defense contractor, slashed its 2009 earnings forecast by more than 60 cents a share after falling stocks eroded pension assets.

The negative return on plan assets in 2008 and the change in the discount rate will increase 2009 pension expenses to about $1.04 billion, more than double the $462 million in 2008, Bethesda, Maryland-based Lockheed said in its annual report filed in February. About 85 percent of the increase was driven by the drop in plan assets, Lockheed said.

Dow Contributions

Dow Chemical, the largest U.S. chemical maker, expects to more than double pension contributions to $376 million from $185 million last year, according to a Feb. 20 filing. Midland, Michigan-based Dow’s pension was underfunded by $4 billion at year-end after posting a $526 million surplus a year earlier.

Sears Holdings Corp., the largest U.S. department-store chain, may need to almost triple its pension contributions to $500 million in 2010 from $170 million this year if pension reforms aren’t enacted and the markets fail to recover, the Hoffman Estates, Illinois-based company said in a filing.

Caterpillar, the largest construction-equipment maker, said Jan. 26 that it had a $3.4 billion year-end charge because of lower returns on pension assets. The company plans to put $1 billion into the pension fund this year, Chief Executive Officer Jim Owens said on a Jan. 26 conference call with analysts.

“Hopefully, the equity markets will return to some semblance of normal multiples and therefore recover,” Owens said.

Caterpillar’s pension obligations were $5.8 billion underfunded at the end of 2008, according to a Jan. 26 filing. The Peoria, Illinois-based company said in the filing it aims to keep its portfolio 70 percent invested in equities.

‘Near the Bottom’

“Some companies that see the market as near the bottom and are expecting a rebound do not want to take money out of equities now and are definitely not rebalancing,” Mercer’s Hartshorn said.

President George W. Bush late last year signed a law easing pension-funding requirements by eliminating some penalties on companies whose funding falls below federal guidelines.

Trade groups have lobbied lawmakers on four Congressional committees for more regulatory changes, according to the lobbying group Committee on Investments of Employee Benefit Assets.

One proposal would allow companies to make contributions to their pension funds for 2009 and 2010 based on 105 percent and 110 percent of their 2008 required contribution. Another proposal would prevent the growth in pension-fund shortfalls for companies paying interest on their plans’ 2008 losses.

No legislation has yet been introduced, the group said.

“Members of Congress do recognize there is a problem,” the Committee on Investments’ Schub said. “Unfortunately, this stuff is complicated and they have so much on their plate.”

Members of Congress better start paying attention to the pension tsunami because it will only get worse from here.

I expect equities to rally in Q2, but don't be fooled into believing this is the beginning of a new bull market. That is a pipe dream. There are still far too many challenges that plague the earnings of major corporations, including the underfunded status of their pension plans, weak credit markets and rising unemployment around the world.

In my last post, I wrote about how the Hospitals of Ontario Pension Plan (HOOPP), which runs pensions for Canadian health-care workers, increased its bond holdings and cut equity investments to limit losses in 2008.

On Wednesday, Bloomberg reports that South Korea’s government said it eased the national pension fund’s asset choices, giving the country’s largest investor more flexibility to avoid stock purchases when markets tumble:

National Pension Service, which avoided losses in last year’s global rout, will target a domestic stocks weighting of between 10 percent and 24 percent, wider than the current 12 percent to 22 percent range, the welfare ministry said today in an e-mailed statement. The change may “prevent us from excessively buying stocks, in order to meet the permitted limit, when stock prices fall,” the statement said.

“The fund appears to have a bit of a negative view for equities,” said Park Se Girl, a fund manager at Meritz Asset Management Co. in Seoul, which oversees the equivalent of $1.6 billion in assets. “National Pension has served as a safety net for the market when stocks fell as it has to buy stocks to be in the permitted range, and now that role may weaken a bit.”

The government in January last year asked National Pension Service and other state-run investors to buy shares ahead of schedule to stabilize the market as the global meltdown accelerated. National Pension Service’s 236 trillion won ($174 billion) of assets were little changed in 2008 as bond holdings countered the equities slump, outperforming other nations’ funds.

Albeit the worst return in the Korean fund’s two-decade history, it beat the 26.6 percent tumble for the California Public Employees’ Retirement System in the seven months ended Jan. 31, and the 31 percent plunge for Singapore’s Temasek Holdings Pte in the eight months ended Nov. 30.

Asset Mix

South Korea’s fund will now get more flexibility to mix investments between stocks and bonds. National Pension, which was set up in 1988 and covers private-sector employees and those who are self-employed, posted returns of more than 5 percent between 2003 and 2007.

“The recent volatility in domestic stocks has increased much above the level we previously anticipated,” the welfare ministry’s statement said. “High volatility is likely to continue for the time being as expectations of economic recovery vie with concern about a prolonged recession.”

South Korea’s benchmark Kospi stock index has gained 9.3 percent this year after tumbling 41 percent last year, the gauge’s worst performance since 2000, when the technology bubble burst. The global rout has wiped out more than $32 trillion in stock values since the peak in October 2007.

The pension fund will be given a range of as much as 7 percentage points either side of the target weighting for local stocks of 17 percent, the ministry said. Previously, the range was as much as 5 percentage points.

The range for local bond investments will be widened to between 56.3 percent and 82.3 percent of total assets in 2009, or a difference of as much as 13 percentage points either side of the target weighting of 69.3 percent. Previously, the range was as much as 10 percentage points.

It is interesting to see how some pension funds are still aggressively allocating to equities while others are scaling back risk, allocating more to bonds.

My view is that while equities have been clobbered and bond yields are at historic lows, it is foolish to conclude that we hit bottom. In times of great uncertainty, it's better to err on the side of caution, allocating more to bonds to minimize your downside risk.