Make no mistake, the criminality and fraud of most, if not all, DC politicians that is being exposed now, is also occurring in corporate America and at pension funds, especially with regard to fraudulent financial reporting. As an example, Exxon (NYSE:XOM) is now being investigated by the SEC over its asset valuation and accounting practices. The same concept can be applied to pension funds (public and private). The Dallas Fireman and Police Pension fund is the postcard example of both investment and accounting fraud.
The pension time bomb has been activated for a long time but it’s now in the final countdown. Pensions are woefully underfunded even if we give them the benefit of the doubt on their current use of market-to-market. Every pension fund under the sun in this country – because rates are so low – has monthly negative outflows of cash: beneficiaries are being paid more money than is flowing into the fund.
If the stock market declines more than 10% for an extended period of time, nearly every pension fund in the country would blow up. This is why the last two stock plunges, which took the S&P 500 down over 10%, were met by heavy, if not blatant, Fed intervention, which produced a steep V-bounce in the stock market both times.
Yesterday I spoke to a friend/colleague who works at a public pension fund. He said the latest fad in pension management land is to shift money out of hedge funds – which are woefully underperforming the market – and to put even more money into private equity funds. This allows the pension funds to subject that capital to a quarterly mark to market test, rather than an daily or monthly valuation accounting.
The only problem: private equity investments are highly illiquid and the valuation of the underlying investments is an “art” that is not at all based on actual market transactions. This private equity investment mark-to-market “Picasso” leads to extreme “over-marking” of private equity investment valuations at pension funds.
This is also one of the primary reasons that the Fed can not raise interest rates, even if it were true that the economy was improving and the labor market was tight, both conditions of which we know are not even remotely close to accurate but everyone seems content to play along with the joke.
Many pensions have now allocated as much as 20% of the fund to private equity. This is because they can control, to a degree, where the investments are marked and as long as the stock market does not decline, they never have to market them down. But with the example of the Dallas pension fund above, if the beneficiaries are allowed to withdraw all of their money, the fund will have to unload its illiquid private equity investments to meet the outflow requests. Good luck getting anything close to where those investments are marked in the fund. The beneficiaries won’t receive anything close to the current stated value of their pension account.
If the status quo in the markets were to continue for the foreseeable future – which it won’t – pensions funds will run out of cash to pay beneficiaries well in advance of the “foreseeable future.” Without cutting benefits drastically or, in the case of public pension funds raising taxes steeply to cover pension beneficiary outflows, some public pensions will hit the wall within 12-24 months.
Away from private equity investing – which is just another of the many asset bubbles spawned by the Fed’s near-zero interest rate and money printing policy (by the way, the Fed, unbeknownst to many, is still printing money) – Wall Street has been busy stuffing a plethora of high-fee generating asset-backed “investment” securities into the market. These securities exploit the need by pensions to generate much higher investment income. When you hear the term “reach for yield,” think: pigs are greedy, hogs get slaughtered. These securities are hog food.
The only problem is that interest rates are so low now that the risk embedded in the underlying asset pools are much greater than the interest rate compensating the investor for buying these securities. Ratings agency fraud is also present again. This is another instance of the current period of financial insanity “rhyming” with the Wall Street-fueled insanity that led to the 2008 financial collapse.
A perfect example is the latest “brain child” of Wall Street in which the payables from cell-phone bills (the mobile carrier’s receivables) are packed into pools and securitized into “bonds”. Verizon Communications Inc (NYSE:VZ) is the first to do a deal like this. It’s receivables from cell-phone bills were packaged into bonds, received a triple-A rating and were priced at 55 basis points over the benchmark triple-A corporate index. That means it was issued around a 2.67% yield.
Think about this way, would you lend money to a stranger to pay his cellphone bill in exchange for receiving the amount you loaned plus receive a 2.67% annualized rate of interest on the loan next month? There’s a reason the bonds were priced at 55 basis points over standard triple-A bond. If the implied reason were apparent to all, the bonds would be yielding substantially more. Eventually that reason will come to light and the bonds will tank in price.
The Dallas police and firemen had the right instinct: if you are eligible, contact your pension administrator and demand to receive any pension money that can claw out of fund now. Your alternative is to face substantial payment cuts at some point. Eventually your fund will collapse and you will otherwise receive nothing more than an “Oops, Our Bad” letter from your pension fund.