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Tuesday
Oct122010

The small matter of unfunded state & municipal pension liabilities

DateTuesday, October 12, 2010 at 11:42AM

The fraud of Social Security becomes the fraud of General Motors becomes the fraud of California and moves soon to a theatre near you. Owners of municpal paper take note.

The FT today reports US cities face big public pension deficits excerpted below.

Big US cities could be squeezed by unfunded public pensions as they and counties face a $574bn funding gap, a study to be released on Tuesday shows.

The gap at the municipal level would be in addition to $3,000 bn in unfunded liabilities already estimated for state-run pensions, according to research from the Kellogg School of Management at Northwestern University and the University of Rochester.

Now how could that have happened?

Thematically, its the same old stuff.  Shall we take a little flashback to General Motors? Kudos to Tony Jackson of the Financial Times for his article GM is just a hedge fund in disguise (Aug 22, 2010 also excerpted below).

As public offering for GM rev’s up, one might well ask, “How is this going to work?” Well, it’s not going to. The US government, or rather the current & future US taxpayers, have provided us with another opportunity to short a pig. Let’s set aside the sobering competitive reality that we as consumers already know well. No one buys their cars. That’s why they went bust. Let’s further set aside the sobering global competitive threats of Ford, Honda, Toyota, and Hyundai.

GM has pension liabilities of some $100 billion, funding of which is well, running a bit short. Quelle surprise! The stated deficit of some $27 billion bananas is, of course, based on the assumption that the existing pension assets earn 8.5% for the rest of time in eternity AND that GM operates with sufficient profitability and cash flow to fund its pension expenses and everything else.

Well, good luck with that 8.5%. What…? You need a bigger number, no problem? Just pop the asset mix and up risk a bit. Why not? 

The reality of all this is that GM…is in economic terms a hedge fund, with its operations a mere sideline. And as a hedge fund, it is fairly racy.

Mr Ralfe calculates that only 35 per cent of its assets are in investment-grade bonds, either Treasury or corporate. The rest is spread across real estate, equities, hedge funds, private equity and so forth.

This poses an interesting question. Why would investors put their money into GM, rather than into regular hedge funds that are not distracted by the vexing business of selling cars in competition with the giants of Asia?

Oh, good. But wait, there’s more. The first half operating earnings of GM were about $2.9 billion (the highest since 2004) so let’s double it to ballpark 2010’s annual operating earnings, well, call it a little less than $6 billion. Let’s set aside the hockey stick earnings forecast by management and soberly assume that the 8.5% sustainable investment return on the pension assets is overly aggressive, at least at the front end of the period. GM then has to dedicate at least all of its operating earnings for the next 6-8+ years minimum to merely funding the pension liability. Forget about growing warranty expense or debt service or funding unsold inventory. Kaboom! We’re all shareholders on this bus.

Now, let's now move our gaze to California which is now in a funding crisis, acutely short of cash with limited financing options...  all dressed up, sitting by the phone at 7 pm on prom night. CALPERS, being helpful sympathetic types, lob in a call. They know a good deal when they see it, the opportunity to buy every politician in the state with make a prudent bridge loan to a large politically & economically important state whose pensions they run.  CALPERS is, of course, the California Public Employee’s Retirement System. They’re proposing to lend to the state. The cash, of course, comes from the pensions of the state's employees.  Oh, did we mention that many of the CALPERS' pension plans have funding deficits also? Something about understated liabilites and under performance of investment assets…

 Flash back to GM: GM’s annual payments to its US pensioners are running at $9.3bn. On US fund assets of $85bn, that ostensibly requires a return of 10.9 per cent.

Flash back to the Social Security trust fund: there is no social security trust fund.

Systemic risk, anyone?

 

 

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