By Leo Kolivakis for Pension Pulse
Mike Corones of Reuters reports, Chicago’s untenable pension situation (h/t, Suzanne Bishopric):
The headline certainly sounds dire: Chicago sees fiscal doomsday if court suspends pension changes. The reality might live up to the rhetoric.Charles Chieppo is absolutely right, Chicago and Illinois pensions are in such dire straights that there really aren't many good options left to fix them.
The state of Illinois is in nearly untenable financial straits, with an unfunded estimated pension liability of a dizzying $111 billion owing to a long history of failing to fully pay into the pension fund. It sought relief in the form of the state’s Pension Reform Act, which brings cost-of-living payouts into line with inflation rather than a straight 3 percent annual increase. But the bill, which went into effect Jan. 1, was quickly struck down by a Springfield court, and now sits before the Illinois Supreme Court, which is expected to rule on it soon.
Chicago, meanwhile, has a crisis of its own, also due to a historical failure to sufficiently pay into its pension system. As this Reuters graphic shows (click on image above), Chicago’s 2014 pension contribution was $476 million. In that year the city paid out $1.8 billion in benefits to some 55,000 current and retired city workers. And that’s the good news. Projections for 2015 and beyond are well over $1 billion per year in pension payments.
Detroit famously went into bankruptcy in 2013, emerging from it last November when a judge approved a plan allowing the city to shed $7 billion of its $18 billion mountain of debt. At this point it is difficult not to see Chicago’s situation as worse. In July, 2013, Moody’s cut the city’s credit rating by four notches to Baa1, and in December the agency cited a $32 billion adjusted net pension liability, a number that is eight times the city’s operating revenue.
As Charles Chieppo wrote for Governing, “The moral of the story is that when you allow something to get as bad as Chicago’s pension system has, there rarely are any good options for fixing it.”
In December 2013, Illinois passed a huge bill to slay its pension dragon but all that did was kick the can down the road which is why credit rating agencies are cutting the ratings of cities like Chicago, fearing a Detroit-style disaster. Actually, when Chicago blows up, it will make Detroit look like a walk in the park.
Across the United States, there are many city and county pension plans experiencing severe pension deficits. John Mauldin touched upon it in his comment looking at longevity risk, which I covered in my last comment. As Mauldin rightly notes:
Even assuming the 7-8% returns that most pension funds use to calculate the contributions required to fund promised benefits, the funding shortfall is still in the high hundreds of billions of dollars nationwide. But what if you assume a cap rate similar to the return on the 15-year bond? That return was about 3.25% a couple of years ago when a group called State Budget Solutions did a study on the underfunding of public pensions. Using that 3.25% cap rate, they estimate that public pension funds are underfunded to the tune of $4.1 trillion. I should point out that their study included just 250 state-level defined-benefit plans and omitted many smaller county and municipal plans, so the shortfall across all plans is in all likelihood much worse.If you add in cities and counties, that $4.1 trillion figure could easily rise to $5.1 trillion or more. And don't forget, Detroit's pension risks still linger and will be felt across many other cities.
Another U.S. city that caught my attention this week is Tampa. I covered their smoking hot pension fund last March, claiming the returns of one of their outside managers who basically runs the bulk of their assets are too good to be true.
Well Ted Siedle, the Pension Proctologist, just published another doozy for Forbes, $2 Billion City Of Tampa Pension Story Major Media Missed:
Those who lament the demise of investigative journalism should take the time to pore over the lengthy cover story in this month’s Chief Investment Officer magazine,The Riddle of Tampa Bay, by Managing Editor Leanna Orr.God bless Ted Siedle, we need more people like him uncovering all the crap that goes on at public pension funds. And the answer his riddle is simple, powerful vested interests that are milking public pensions dry in fees don't want the New York Times, Wall Street Journal, Washington Post or 60 Minutes snooping around at public pension funds. This is all part of the coming war on pensions.
As Forbes readers know, I have at times harshly criticized pension and money management trade publications for being blatantly pro-industry. In this case, I agree with Editor-in-Chief Kip McDaniel that this is the most important article the magazine has ever published. Further, given the heated national debate regarding the management and sustainability of public pensions, I submit this is precisely the depth of reporting that the complex subject matter demands.
As McDaniel states in his opening Letter From the Editor, thousands of Tampa police and firefighters “rely upon the belief that when they retire, they will be taken care of. “
“I can tell you without an iota of doubt that the structure of the Tampa Fire & Police’s retirement investments is unwise,” he bluntly opines. “There’s innovation—and then there’s whatever this is.”
Investigative journalism is alive and well, but the history of the still-unfolding Tampa pension story reveals how dramatically the media landscape has changed.
Disturbing facts about the unorthodox $2 billion pension were not initially reported, or even subsequently investigated, by major media. In fact, when the crack reporters at The Wall Street Journal and The New York Times weighed in, they largely dismissed the abundant “red flags.”
Forbes Blogger Takes the Lead
The Tampa pension story began here at Forbes two years ago when I wrote an article "Red Flags Abound at $1.6 Billion City of Tampa Firefighters and Police Pension" wherein I stated, that I had two words of advice for firefighters and cops who participate in the City of Tampa Firefighters and Police Pension: Watch Out.
“While I cannot say for certain that your pension’s assets are being mishandled without further investigation, there are ample “red flags” present and I believe an independent forensic review should be undertaken of the fund.
Based upon the documents that I have reviewed, in my opinion, it is impossible for participants in the fund to assess the integrity of the plan’s investments or the plan’s ability to pay benefits.”
I mentioned that the financial statements of the municipal pension on its website at that time stated that they were not designed to provide assurances to pensioners regarding the fund’s ability to pay benefits.
The financial statement on the fund’s website at that time indicated that they had not been audited or reviewed.
The accountant for the Tampa pension was small local firm, Nobles, Decker, Lenker & Cardoso. I asked: Why would a $1.6 billion municipal pension contract with a local accounting firm to provide a mere “compilation” and financial statements that were “not designed” to inform participants, as opposed to using a nationally recognized firm to do a true audit consistent with generally accepted accounting principles– audited financials that would be comprehensible to all?
I didn’t know the answer to even that question but, digging deeper, more accounting concerns emerged.
In the 30 years I have been involved with public funds, I had never seen financial statements of a public fund wherein the accountants admitted, “We are not independent with respect to Tampa Firefighters & Police Officers Pension Fund.”
If the accounting firm was not independent, i.e., it was conflicted for some reason and is not actually auditing the fund, then what was the value, or indeed purpose, I asked, of the financial statements it had prepared?
There were more red flags. 100% of the assets of the $1.6 billion pension had for the past 39 years been managed by a single investment advisor and the Tampa fund represented approximately 80% of the money management firm’s assets under advisory. So much for diversification of manager risk, I noted.
It was a red flag, in my opinion, when a manager seemingly failed to attract additional clients over decades and remained dependent upon a single public pension.
As to how well the fund had performed over time, I stated that the answer was unclear for two reasons. First, there were no audited financials of the fund to rely upon. Second, the limited performance summary and investment history provided by the manager on the fund’s website, in my opinion, raised at least as many questions as it answered.
Three weeks after my initial Tampa article, I wrote "New Red Flags Related to Tampa Firefighters and Police Pension “Audited” Financials". Following my original article—miraculously – audited, as well as so-called audited financial statements appeared on the fund’s website.
Why a public pension would present to the public on its website unaudited financials omitting “substantially all of the disclosures required by accounting principles generally accepted in the United States of America”—financial statements that were “not designed to inform” pension participants about such matters– when audited financials existed, was hard for me to understand. However, the audited and so-called audited financial statements recently added on the website raised far more troubling questions about the management of the billion-plus public pension.
For example, in the past ten years, the pension had changed auditors from Ernst & Young in 2001-2002, to no-named auditor of a draft in 2002-2003, to KPMG for a few years, then back to Ernst & Young for a spell and, most recently, to the firm of Moore Stephens Lovelace, P.A.
When companies change auditors frequently, or without explanation, it is considered a major red flag by investors and regulators alike. I’d never seen a pension whip through auditors as quickly as this one.
This public pension fund was exceptional both in having zero turnover of investment advisors, using a single money manager to oversee 100% of its assets for the past 40 years, and in changing auditors every couple of years.
But there were more red flags.
The 10% assumed rate of return on investments disclosed in the pension’s financials at that time was absurdly high– in excess of the rate deemed achievable by legendary investor Warren Buffett. Berkshire Hathaway’s pension projected a paltry 7.1% overall return.
According to the performance summary and investment history of the pension, the longstanding investment manager’s stock picks had nearly tripled the S&P 500. Why other public pensions hadn’t retained this Buffett of Atlanta to manage 100% of their assets remains a mystery, I concluded.
The Wall Street Journal Trumpets the “Oracle of Tampa”
Three months after my two articles, The Wall Street Journal—while noting additional unusual features—such as the fund’s performance manager was a one-woman firm in Maryland—wrote a glowing piece naming the fund’s manager the“Oracle of Tampa.”
The manager has understandably ever-since included the WSJ article his marketing materials. More surprising, the public pension’s home page added a link to News and Media regarding its sole asset manager which takes readers to the manager’s website for favorable articles.
I have never, in three decades of investigations, seen a public pension website linking to an investment manager’s marketing materials. Clearly there is a very, very close relationship between this public pension and its longstanding sole manager.
To be fair, the WSJ reporter did mention my concerns about Tampa toward the end of the article.
“Still, Edward Siedle, a former Securities and Exchange Commission lawyer and founder of Benchmark Financial Services in Ocean Ridge, Fla., says the unusual setup warrants a close look by regulators.
“A fund this size should have a nationally reputable consultant overseeing its investments,” says Mr. Siedle.
“It lacks many of the prudent safeguards that are common at public funds.”
Soon CNBC was profiling the Oracle of Tampa’s Top Stock picks.
A Blogger Underwhelmed By Oracle
Shortly after the WSJ not-so-deep dive, in Investment Oracles Aren’t What they Used to Be, Money Markets blogger Eric Nelson concluded: “… while Tampa is to be commended for avoiding the hype and empty promises of expensive Wall Street alternatives like private equity and hedge funds, and their recent performance exceeds the low bar that has been set by other $1B+ pension funds, they aren’t employing any “oracles” and their returns are at least 1.5% per year lower than they should be were they to make the logical transition to a more diversified and balanced Asset Class portfolio.”
The New York Times Un-Muddies the Waters
A year later, in March 2014, The New York Times gushed about a pension fund that invests against the rules, and wins. For decades, the pension has “unheard-of returns,” said the Times reporter who had apparently unheard-of my concerns.
The article began by brushing aside some pesky process issues.
“As for being diversified, which is the mantra of nearly all institutional money managers and consultants, it isn’t. A single outside manager makes all investment decisions, and the fund’s assets are concentrated in a relatively small number of stocks and fixed-income investments.
In short, the Tampa pension fund pretty much breaks all the conventional rules of fund management.
But then there are the numbers…”
The moral of the NYT story apparently being, as long as you win investing workers’ pension monies, lack of prudent process is of no concern. (Any seasoned pension professional will tell you just the opposite: prudent process arguably matters more than win-or-lose investment results.)
Chief Investment Officer Magazine Focuses Upon Compliance and Investment Performance
Having established that the Tampa fund is unusual and “breaks all of the conventional rules” of pension management, Chief Investment Officer magazine goes further to rightly focus on whether the fund’s and the manager’s investment performance has been accurately reported.
When asked by the reporter to provide composite returns covering all client accounts, the manager declined but reportedly said they do exist.
As the magazine details, there are a number of Florida public pensions that have accounts with the same Tampa manager but wildly different performance.
“Red flag, red flag, red flag. The ground is covered in red flags,” a former head of risk for several major financial institutions is quoted as saying.
The Tampa riddle remains unanswered. Stay tuned as, hopefully, major media, random bloggers or Chief Investment Officer magazine takes another bite at the apple.
Riddle Me This
Riddle Me This: Why is major media sitting on the sidelines as the greatest financial story in the history of America—public pension secrecy—unfolds?
Why are newspapers that once boldly published sensitive information such as the Pentagon Papers, now fearful of publishing widely-disseminated hedge fund and private equity offering documents?
Are hedge fund billionaires scarier to publishers than the Department of Defense and the NSA? (Or could it be they are potential buyers of struggling media?)
Granted, pension matters are complex and harder still to explain to the public. On the other hand, we are in the midst of a heated national debate about pensions and retirement security. Major news organizations need to step to the plate, dig deeper into pension stories, and, in so doing, hopefully regain some semblance of the reputation for integrity they once had.
By the way, shady pension dealings are going on all over, not just the United States. I blasted the Auditor General of Canada for dropping the ball in its 2011 Special Examination which was nothing more than a sham, basically rubber stamping the findings of PSP's financial auditor, Deloitte. There was no mention of how André Collin, PSP's former head of Real Estate, joined Lone Star right after directing billions to that fund while at the Caisse and PSP (he's now the President at Lone Star).
Moreover, the media in Quebec and the rest of Canada keep covering up the Caisse's ABCP scandal. Why? Because powerful, wealthy interests who control the media buried that story. Nobody will ever find out who was ultimately responsible for that $40 billion train wreck because the players involved were silenced and taken care of with cushy jobs elsewhere.
Of course, the masses are asleep, until the next scandal breaks out. Pensions and pension governance aren't sexy topics. Much funner parading Italian Canadian gumbas with funny sounding names on television and grilling them at the Charbonneau Commission, wasting millions of Quebec taxpayers' dollars. God forbid we set up a serious commission to grill the hell out of Quebec's financial elite to uncover what really happened at our large public pension funds and who was ultimately responsible for losing billions of dollars.
I better stop because I'm getting very cynical and the lawyers start getting very edgy, worried that I may "explode" at any time. The hypocrisy and willful ignorance of the media is downright disturbing. My stomach churns every time I write about this stuff but by the same token, we need to shine a light on public pension funds because all stakeholders have a right to know what is going on there.
Let me end by stating over the next decade, we will see many more city and county pension plans go belly up just like in Detroit. This is why I've long argued to amalgamate them and have the assets managed by state entities where the governance is far from perfect, but much better than what they have at most cities (there are exceptions but this would be the prudent thing to do).
Courtesy Leo Kolivakis, founder of Pension Pulse (EconMatters author archive here)
The views and opinions expressed herein are the author's own, and do not necessarily reflect those of EconMatters.
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