Time to count your wealth in how many chickens you have and how much gas you can buy
Over the past year, the biggest casualty to emerge as a result of global NIRP (or close to it) monetary policy have been pension funds, which have had two choices: either suffer losses as yields on new fixed income investments barely cover (and in some case don’t), or scramble for duration (or outright risky investments like junk bonds and high beta stocks).
In August, we created the chart below as a simplistic illustration of the pension “duration dilemma.” The chart graphs how a pension liability grows in a declining interest rate environment versus the value of 5-year and 30-year treasury bonds. As you can see, a $1BN pension that is fully funded at prevailing interest rates would be nearly $700mm underfunded if interest rates declined 300bps and all of their assets were invested in 30-year treasury bonds. The result is obviously even worse if the fund’s assets are invested in shorter duration 5-year treasuries.
So what do pension fund managers do when perpetually declining interest rates continue to
drive their funded status lower and lower despite one’s return profile? Well, there is little choice: one has to move further and further out the yield curve in an
attempt to match asset duration with that of one’s liabilities. That, or reach for the skies by buying the riskiest assets possible, and pray for a home run.
Unfortunately, most pension fund managers better known as “dumb money”, are hardly star stock pickers. One such example is the fast imploding Dallas Police & Fire Pension (DPFP), which covers nearly 10,000 police and firefighters, and whose troubles we first covered back in August, is on the verge of collapse as its board and the City of Dallas struggle to pitch benefit cuts to save the plan from complete failure. According the the National Real Estate Investor, DPFP was once applauded for it’s “diverse investment portfolio” but turns out it may have all been a fraud as the pension’s former real estate investment manager, CDK Realy Advisors, was raided by the FBI in April 2016 and the fund was subsequently forced to mark down their entire real estate book by 32%, thereby exposing just how great the risk truly is when pension funds swing for the fence… and miss.
Things only got worse when news of the fund’s woes spread, and as we reported in September, Dallas police officers caught on to the ponzi and rushed to withdraw retirement funds as quickly as possible before the whole system goes bust. As reported by a local ABC affiliate, Dallas police officers are retiring at a record rate and opting for full cash withdrawals of their pension benefits as opposed to equal monthly distributions for life (apparently they don’t think the fund will be around long enough to pay them for very long).
Through the first two weeks of September, there have been 21 Dallas police officers who retired. Multiple sources told NBC 5 that commanders are bracing for many more retirements over the next two weeks as well.
The Dallas Police Department did not foresee the volume of retirements this month. In early August, Deputy Chiefs told city council members in a presentation that they projected 14 retirements between Aug. 9 and Oct. 1.
In short, declining returns, a mismatched asset-liability book, and a surge in redemptions: the three things that no fund managers wants to hear, let alone at the same time.
Unfortunately, for the Dallas Police & Fire Pension, it is now too late, as none other than Dallas mayor Mike Rawlings appears to have discovered. As ABC reports, Mayor Rawlings told the state’s Pension Review Board that recklessness led to the financial crisis of the Dallas Police and Fire Pension Fund.
“This is much like a Bernie Madoff scheme, if you ask me,” he said.
Showing an impressive understanding of the underlying problems – if sadly a realization that has come too late – the mayor said past pension fund members guaranteed themselves 8-to-10% returns in their retirement fund, called Drop. Some left with millions in their accounts. On top of that, “there were bad investments” he said quoted by ABC.
It left behind a huge mess that threatens to bankrupt the fund and cost Dallas tax payers billions.
“The City of Dallas tax payer is the punching bag in this issue,” Rawlings said.
Fear not, Mike, you are just the canary in the coalmine as soon most other pension funds stuck in a time of near zero interest rates will soon find out. They will also realize that having kicked the can far too long, the only way to “remedy” the problems at this late stage may ultimately led to local rioting.
According to ABC, the pension board wants the city to contribute $1.1. billion in 2018, but to do that, they would have to increase the property tax rate by 130%.
For obvious reasons, the major – realizing he would immediately lose his job (or worse) if property taxes were doubled – was unimpressed, and said the city has already paid its share, and to do more could be illegal.
Instead, he did what any other self-respecting politician would do: blame others: Rawlings said past fund managers failed police and fire fighters by mismanaging the fund. However, four City Council members have also been on the board, making up a third of the board. So there is plenty of blame to go around.
“You had the perfect storm coming together and all of them screwing it up,” said Fred Fraizer, president of the Dallas Police Association. “So, now who is on the hook? The taxpayer, the employer, the officers that receive the pay.“
Unfortunately, by the time the blame game arrives, it is far too late, as not only does it resolve nothing, but leads to even more dirty laundry (so diligently covered up over the years of rising asset prices) finally emerging, and assures far more pain for all those involved… as local police and firefighters, who are about to see a major cut to their assured pension benefits, will soon find out.
Sure enough, the head of the state’s pension review board seemed frustrated with all involved. “We seem to be at a stalemate and at a place where more of the discussions is about blame than around taking responsibility and moving forward,” he said.
Frazier and the mayor agree that it takes everyone coming together to solve this problem. Both say there needs to be a long-term plan.
They are right, even if about 6 years too late. We just hope they include the Fed, and the world’s central banks in the conversation, whose actions are the primary reason for why millions of state and federal workers around the US (and the globe) are about to lose some or all of their “guaranteed” entitlements.