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?
Update on Tuesday, October 12, 2010 at 12:43PM by
hb
The WSJ reports that the “U.S. government could continue to be a shareholder in General Motors Co. for several years as it gradually reduces its majority stake, Chief Executive Dan Akerson said Thursday.” Yes, several more years, indeed.
Update on Tuesday, October 12, 2010 at 08:57PM by
hb
ed - oops, some of the initial editing didn't take. Fixed now, we hope.
Update on Thursday, October 21, 2010 at 10:26AM by
hb
The data below, estimated by Joshua Ruah an associate professor of finance at the Kellogg School of Management at Northwestern University, needs to be supplemented by the list of the 11 best states so we may observe an object lesson in the mobility of capital that will accompany the progress of time and increases in tax burden of these states (the following excerpted from linked article).
And Now, 11 State Pension Funds That May Run Out of Money
#1 Illinois
Year pension fund runs out: 2018
Bill in the following year: $13.6 billion
Share of state revenue: 32%
#2 Connecticut
Year pension fund runs out: 2019
Bill in the following year: $4.9 billion
Share of state revenue: 27%
#3 Indiana
Year pension fund runs out: 2019
Bill in the following year: $3.6 billion
Share of state revenue: 17%
#4 New Jersey
Year pension fund runs out: 2019
Bill in the following year: $14.4 billion
Share of state revenue: 34%
#5 Hawaii
Year pension fund runs out: 2020
Bill in the following year: $1.7 billion
Share of state revenue: 24%
#6 Louisiana
Year pension fund runs out: 2020
Bill in the following year: $4.3 billion
Share of state revenue: 27%
#7 Oklahoma
Year pension fund runs out: 2020
Bill in the following year: $3.7 billion
Share of state revenue: 30%
#8 Colorado
Year pension fund runs out: 2022
Bill in the following year: $7.8 billion
Share of state revenue: 54%
#9 Kansas
Year pension fund runs out: 2022
Bill in the following year: $2.5 billion
Share of state revenue: 23%
#10 Kentucky
Year pension fund runs out: 2022
Bill in the following year: $5.3 billion
Share of state revenue: 35%
#11 New Hampshire
Year pension fund runs out: 2022
Bill in the following year: $1.0 billion
Share of state revenue: 30%