You must go, pronto, and read Matt Taibbi’s latest expose, on how hedge funds are plundering public pension funds, meaning pension funds managed on behalf of government employees like policemen, sanitation workers, and teachers. Taibbi describes how a concerted PR campaign has made workers the scapegoats for large pension shortfalls when in fact public officials and unscrupulous financiers (both through their machinations with these funds and via damage done by the global financial crisis) are the real perps.
Taibbi describes how the fact that they are exempted from ERISA meant their overseers, state and local politicians, could play fast and loose. As he explains:
Politicians quickly learned to take liberties. One common tactic involved illegally borrowing cash from public retirement funds to finance other budget needs. For many state pension funds, a significant percentage of the kitty is built up by the workers themselves, who pitch in as little as one and as much as 10 percent of their income every year. The rest of the fund is made up by contributions from the taxpayer. In many states, the amount that the state has to kick in every year, the Annual Required Contribution (ARC), is mandated by state law.
Chris Tobe, a former trustee of the Kentucky Retirement Systems who blew the whistle to the SEC on public-fund improprieties in his state and wrote a book called Kentucky Fried Pensions, did a careful study of states and their ARCs. While some states pay 100 percent (or even more) of their required bills, Tobe concluded that in just the past decade, at least 14 states have regularly failed to make their Annual Required Contributions. In 2011, an industry website called 24/7 Wall St. compiled a list of the 10 brokest, most busted public pensions in America. “Eight of those 10 were on my list,” says Tobe.
Among the worst of these offenders are Massachusetts (made just 27 percent of its payments), New Jersey (33 percent, with the teachers’ pension getting just 10 percent of required payments) and Illinois (68 percent). In Kentucky, the state pension fund, the Kentucky Employee Retirement System (KERS), has paid less than 50 percent of its ARCs over the past 10 years, and is now basically butt-broke – the fund is 27 percent funded, which makes bankrupt Detroit, whose city pension is 77 percent full, look like the sultanate of Brunei by comparison.
Here’s how it played out in New Jersey, as we wrote in 2011:
And how exactly did the crisis “reveal” that some pension funds were close seriously under water? A more accurate rendition would be that, at least in New Jersey, the state has been raiding the pension kitty for over 15 years. This is not news to anyone who has been paying attention, any more than underfunding of corporate pensions. In the Garden State’s case, Governor Chris Christie skipped the required $3.1 billion pension fund contribution last year. He claimed this move was to force reform, but what impact does another $3.1 billion failure to pay have on an unfunded liability that was already over $50 billion?
The shell game started in 1995 with Christine Todd Whitman. As Bob Herbert reported:
Now many of the gains made over a quarter of a century are in danger of slipping away because the current Governor, Christine Todd Whitman, has chosen to finance her political ambitions with a popular buy-now, pay-later economic policy that will place a financial stranglehold on future generations of New Jerseyans….
This is best illustrated by Mrs. Whitman’s decision to withhold billions of dollars that should be going into the public employee pension funds over the next few years, and using the bulk of that money to balance the state budget. Then, with an audacity that dazzles her supporters and even draws grudging admiration from opponents, Mrs. Whitman smiles and characterizes the withheld funds as savings.
Of course, they are not “savings” — not in any sense of the word. The pension obligations at some point will come due and future generations will have to meet them.
Not only will the money have to be made up, but future taxpayers will be deprived of the income that the money — if properly invested now — would be expected to generate…The changes that she has made have been drastic. According to the New Jersey Education Association, which has filed suit against the state, the employer contributions to the pension system this year will be as much as 96 percent below the amounts contributed in the early 1990’s.
The state also did a swell job of investing the money it did have. Per a 2009 FireDogLake article:
Orin Kramer is also Chairman of the New Jersey State Investment Council, which is tasked with oversight of the state’s public pension system. In 2006 he successfully pushed to shift a huge chunk of the state’s $72 billion pension fund to private money managers rather than state employees. Kramer was the “prime architect of the diversification strategy” that saw union retirees pick up the tab for $115 million in Lehman Brothers losses on money invested shortly before the firm’s collapse
And the Lehman losses were not a one-off; New Jersey has the dubious distinction of being the only state ever reprimanded by the SEC for pension mismanagement, including phony accounting
Oh, and who is Orin Kramer? He’s the epitome of the problem Taibbi focuses on in his piece, the politically connected hedgie. His firm, Boston Provident, manages hedge funds. He was under consideration to be the #2 at Treasury under Jack Lew. Here’s what we wrote when his name was mooted:
And as for the real reason for Kramer being on the short list, it’s undoubtedly due to his being a monster bundler for Obama. I’m clearly behind the times; I thought fundraising payoffs were limited to ambassadorships and heading organizations like the Export-Import Bank. Now I infer you can buy yourself a seat at the table. In 2008, the New York Observer called him “King of the New York Obamasaurs“. In 2012, WNYC listed Kramer as one of only two New York bundlers who had raised more than $500,000 for Obama for 2008 and 2012. And this was as of February 2012!
Back to Taibbi’s piece. He does the important service of discussion how the Pew Charitable Trust is not the benign, independent foundation that most people believe it to be. Pew was set up to oppose New Deal and other “socialist” reforms. Even now, among pollsters, it’s recognized for having a right-wing slant on economic matters (poll results can be skewed significantly by adept statement and ordering of questions). I was tempted to write about how its questions on its polls about Snowden were skewed, but never got around to it.
Pew has been pushing the “public pensions are broke” meme and shifting blame to employees:
In 2007, Pew began publishing an annual study called “The Widening Gap,” which aimed to use states’ own data to show the “gap” between present pension-fund levels and future obligations. The study quickly became a leading analysis of the “unfunded liability” question…
In 2011, Pew began to align itself with a figure who was decidedly neither centrist nor nonpartisan: 39-year-old [former Enron energy trader and later hedge fund manager/billionaire] John Arnold….
In 2011, Arnold and Pew found each other. As detailed in a new study by progressive think tank Institute for America’s Future, Arnold and Pew struck up a relationship – and both have since been proselytizing pension reform all over America, including California, Florida, Kansas, Arizona, Kentucky and Montana. Few knew that Pew had a relationship with a right-wing, anti-pension zealot like Arnold. “The centrist reputation of Pew was a key in selling a lot of these ideas,” says Jordan Marks of the National Public Pension Coalition. Later, a Pew report claimed that the national “gap” between pension assets and future liabilities added up to some $757 billion and dryly insisted the shortfall was unbridgeable, minus some combination of “higher contributions from taxpayers and employees, deep benefit cuts and, in some cases, changes in how retirement plans are structured and benefits are distributed.”….
[E]ven if Pew’s numbers were right, the “unfunded liability” crisis had nothing to do with the systemic unsustainability of public pensions. Thanks to a deadly combination of unscrupulous states illegally borrowing from their pensioners, and unscrupulous banks whose mass sales of fraudulent toxic subprime products crashed the market, these funds were out some $930 billion. Yet the public was being told that the problem was state workers’ benefits were simply too expensive
So what’s the solution? Even more reaching for return, as in putting pension funds in high-risk, high fee alternative investments. As we’ve discussed in our private equity series, public pension funds have long been deeply in bed with private equity funds precisely because they want those supposed returns really really badly and have been willing to accept all sorts of conditions that no prudent investor should tolerate, like insane secrecy requirements, glaring conflicts of interests, and going to great lengths to help funds evade taxes (more on that soon). The hedgies are latecomers to recognizing that public pension funds are great kitties to be plundered. And we see the hedgies copying the PE playbook we’ve described. For instance:
In fact, in recent years more than a dozen states have carved out exemptions for hedge funds to traditional Freedom of Information Act requests, making it impossible in some cases, if not illegal, for workers to find out where their own money has been invested.
The way this works, typically, is simple: A hedge fund will refuse to take a state’s business unless it first provides legal guarantees that information about its investments won’t be disclosed to the public. The ostensible justifications for these outrageous laws are usually that disclosing commercial information about hedge funds would place them at a “competitive disadvantage.”…
Hedge funds have good reason to want to keep their fees hidden: They’re insanely expensive. The typical fee structure for private hedge-fund management is a formula called “two and twenty,” meaning the hedge fund collects a two percent fee just for showing up, then gets 20 percent of any profits it earns with your money. Some hedge funds also charge a mysterious third fee, called “fund expenses,” that can run as high as half a percent – Loeb’s Third Point, for instance, charged Rhode Island just more than half a percent for “fund expenses” last year, or about $350,000. Hedge funds will also pass on their trading costs to their clients, a huge additional line item that can come to an extra percent or more and is seldom disclosed. There are even fees states pay for withdrawing from certain hedge funds…
On Wall Street, people are beginning to clue in to the fact – spikes notwithstanding – that over time, hedge funds basically suck. In 2008, Warren Buffett famously placed a million-dollar bet with the heads of a New York hedge fund called Protégé Partners that the S&P 500 index fund – a neutral bet on the entire stock market, in other words – would outperform a portfolio of five hedge funds hand-picked by the geniuses at Protégé.
Five years later, Buffett’s zero-effort, pin-the-tail-on-the-stock-market portfolio is up 8.69 percent total. Protégé’s numbers are comical in comparison; all those superminds came up with a 0.13 percent increase over five long years, meaning Buffett is beating the hedgies by nearly nine points without lifting a finger.
Hedge funds on the whole have done not at all well in the wake of the crisis. Even before the bust, returns were less than impressive simply because too many people were becoming hedgies, and to get the blessing of the institutional gatekeeper, you have to follow a particular strategy, such as global macro, distressed investing, “event driven” (special situations and merger arbitrage), market neutral, etc. You need to stay within your style or you get accused of style drift. With hedgies being tracked into particular flavors of investing, you began to see alpha (manager outperformance) diluted by the amount of competition. Hedge funds were admitting even before the crisis that what they were really selling was “synthetic beta” which is fancy speak for a return pattern that id different from that of other asset classes and therefore is a useful addition to a portfolio. That’s all well and good, but those big fees are supposed to be for alpha. You can create all sorts of synthetic beta much cheaper than that. But too many people benefit from the scam to encourage investors to do that:
Many states have engaged middlemen called “placement agents” to hire hedge funds, and those placement agents – typically people with ties to state investment boards – are themselves paid enormous sums, often in the millions, just to “introduce” hedge funds to politicians holding the checkbook.
But the PE funds, who’ve been at this game longer, are even bigger pigs more practiced:
In California, the Apollo private-equity firm paid a former CalPERS board member named Alfred Villalobos a staggering $48 million for help in securing investments from state pensions, and Villalobos delivered, helping Apollo receive $3 billion of CalPERS money. Villalobos got indicted in that affair, but only because he’d lied to Apollo about disclosing his fees to CalPERS. Otherwise, despite the fact that this is in every way basically a crude kickback scheme, there’s no law at all against a placement agent taking money from a finance firm.
So please read and circulate this piece. It’s an important corrective to the many-faceted “blame the little guy for the failings and corruption of our elites” narrative. And only via relentless re-education do ordinary citizens have a chance of defining problems properly, which is a necessary condition for coming up with effective remedies.