Speaking of Doom

Readers may recall my alarm that the city and state pension funds were moving into “alternative investments” such as hedge funds right when those funds were likely to tank. Many don’t hedge at all; they just leverage investments with debt, meaning a small loss in reality is a 100 percent lost for investors, with the possibility of similar gains if things go well, and massive fees in either case. A knowledgeable person told me it was no problem, because legally pension funds may only invest a few percent in such risky investments.

But now I read that the state pension funds already have received permission from the state legislature to increase the share in alternative investments fromo 15 percent to 25 percent, and State Comptroller DiNapoli, undoubtedly encouraged by Wall Street, is asking the legislature to remove any limits at all. The reason — the pension funds don’t have enough money to pay the promised benefits, so they have to take more risks to increase the rate of return.

All you have to do is increase the expected rate of return, and suddenly really rich pension benefits appear to cost little or nothing. So in 2000, when a whole bunch of pension sweeteners were passed, the assumed rate of return was increased to 8.0%. At that time, however, asset prices, notably stocks, were inflated. No way the prices were going up 8 percent from those levels. In fact, asset prices are STILL inflated by all traditional measurements of value — with stocks, bonds, and real estate heading for additional losses.

Indeed, aside from money controlled by others, our net savings has been going to a short term treasury fund with a low interest rate, a fund that is LOSING value relative to inflation each and every day. There is no better alternative, unless one wants to roll the dice and hope to roll a seven — taking the risk of snake eyes. I wouldn’t do that with my money. But the state is happy to.

Why not gamble. Heads you win and hand out more pension sweeteners and claim the cost is zero. Tails you lose and taxes are increased and services are slashed, but your government job, healthcare and pension are guaranteed.

All over the country similar public employee pension funds are taking similar gambles for similar reasons, and losing. That’s one reason I wouldn’t invest in municipals — especially ours — because right at the moment Congress is pushing the pliable rating agencies to increase the ratings of government debt, bankruptcies due to pension, retiree health care, and debts are becomming more likely.

The only certainty about these alternative investments is that those who organize them get paid far more richly than those who issue and trade traditional stocks and bonds. But the city and state are willing to grasp at any straw, rather than admit what all those pension deals cost and start collecting the money required to pay for it. This is all about timing — putting off the burden until the financial disaster is general, so no one can figure out what caused any piece of it. They will take out as much as they can for as long as they can.

What should they do? Wait another year or so. Then do a “market value restart,” and figure out what the actual rate of return was over the past decade, and use that in lieu of the “expected” 8 percent return.

Update: the very knowledgeable person, who is highly knowledable in financial matters, is shocked that the limit is 25%, and totally shocked that it might increase further. “I would get on a bus to Albany over that — who do I yell at,” this person said. Too late. There is no one to yell at, because they can do what they want and there is nothing we can do about it.