Stupidity isn't limited to the Federal level - I was wondering how long it would be before I saw this headline here in Oregon:
PERS FALLS INTO A FAMILIAR CHASM
And here's a good reason why the market can't recover:
"Unless the stock market stages a major recovery, bringing the system's assets and liabilities back into balance, taxpayers will have to pony up more money to cover the guaranteed benefits of many of the system's 320,000 public employee participants."
This bear really puts to rest the idea that the 2000-2 affair was a once-a-generation bear. It was nothing but a cub...
oregonlive.com
The Oregon Public Employees Retirement System is back in a deep hole.
After riding 2003 legislative changes and boom-time investment returns to erase a $17 billion deficit and become one of the best-funded public pension systems in the country, PERS has seen its net assets plummet from more than $60 billion in late 2007 to less than $40 billion at the end of February.
More on PERS
At the end of this article, Oregonian reporter Ted Sickinger looks at how PERS investments have fared. Use the links below to go to each section:
The stock portfolio
Real estate
Private equity funds
Everything is down at once, even the investments that were supposed to be counter-cyclical. And the system's deficit is now in the neighborhood of $18 billion, not counting some of the losses the fund experienced in the first three months of the year or the spike in the market during the past three weeks.
Unless the stock market stages a major recovery, bringing the system's assets and liabilities back into balance, taxpayers will have to pony up more money to cover the guaranteed benefits of many of the system's 320,000 public employee participants.
Just a year ago, Oregon's public pension system was the envy of its peers because its investment strategy produced higher returns than those in other states. That meant Oregon public employers had to contribute less to fund the system. But Oregon's public pension is also more dependent on investment returns than most, which has left those agencies -- and the taxpayers who finance them -- vulnerable to major cost increases if the market doesn't rebound significantly in the next two years.
Managers in the Treasury Department's Investment Division are cautiously optimistic. They say the stock market is "oversold," trading more on emotion than economic fundamentals. They hope this month's bounce in broad stock market indexes such as the Russell 3000 is evidence of a possible market bottom and recovery.
Click on graphic to view full size
Still, there's a long way back to the system's fully funded comfort zone. Including preliminary estimates of private equity and real estate investment losses last year, Oregon PERS had about 68 cents in assets for every dollar in promised benefits at the end of February. And that includes more than $5 billion in prepaid contributions by state agencies, school districts and municipalities, which issued pension obligation bonds during the previous system crisis to offset their growing liabilities.
This time, the gaping hole in the system has a slightly different cause from five years ago, when a $17 billion actuarial black hole prompted a series of legislative changes to the system. Those changes, and year-end balances, improved the deficit by the end of the year, which is why the gap isn't evident in the chart above.
Back then, PERS officials insist, the underlying problem was the runaway growth in the system's liabilities. All public employees hired before 1996 are guaranteed an 8 percent return on their pension accounts. And before 2003 changes took effect, the system's governing board routinely credited employees' accounts with far more than that during years of strong investment returns instead of funding the system's rainy day reserve.
This time, changes have limited overall liability growth, and the system's immediate deficit has been dug by the meltdown in financial markets.
Oregon PERS is highly dependent on investment earnings to pay promised benefits and keep itself in balance -- the most dependent among 11 Western states analyzed by the system's actuary, Mercer Human Resources Consulting. That's because it has the lowest active employee-to-retiree ratio and the lowest contribution-to-benefit payment ratio among those 11 states.
"About 73 percent of our revenue comes from investment returns, said Dale Orr, an actuarial analyst with PERS. "If investment returns decline, that makes employer rates more volatile."
Last year's market decline wiped out the rainy day reserve that PERS usually relies on during bad market years to keep crediting its older member accounts with a guaranteed 8 percent return. And the net cash outflows from the pension fund to cover benefits over the next five years now represent more than 20 percent of the system's assets.
If employers' rates were adjusted today based on the funded status of the PERS system at the end of 2008, they would spike dramatically. But that won't happen, thanks to an 18-month lag in the system's calculation of employers' rates.
In fact, the rates paid by state agencies, municipalities and school districts to cover benefits are set to go down 2.5 percent July 1 because they're based on the system's funded status at the end of 2007. Back then, the system was coming off a five-year streak in which investment returns averaged more than 15 percent, and PERS had $1.12 in assets for every $1 in liabilities.
PERS' actuary has recommended eliminating the 18-month lag in rate adjustments to better balance the system. But that hasn't happened. And when the impact of last year's market declines are built into rates in 2011, any increase in employer rates will be limited to 6 percent because of collars adopted to soften rate volatility.
Ckick on the graphic to see it full size
PERS managers hope market returns in the interim will soften or eliminate the need for any rate increase. But they're aware that this downturn and recovery may be different, and are wrestling with whether to adopt a more conservative investment mix.
That's something of a Catch-22.
If the system has lost $20 billion since 2007, said Ron Schmitz, chief investment officer with the state Treasury's investment division, "how long is it going to take to make that up if we get more conservative?"
-- Ted Sickinger;
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The stock portfolio: No matter the strategy, the results are dismal
Oregon's public pension system hires the smartest Wall Street managers money can buy to run its huge portfolio of publicly traded stocks. And it pays them handsomely -- $91 million in fees during 2007 -- with the understanding that, over time, they will outperform the market.
All for naught in 2008, as the 30 or so investment management outfits presided over a 43 percent plunge in Oregon's portfolio to $17.2 billion, a slightly worse performance than the broad market indexes that the state Treasury Department uses as a yardstick to judge those managers' performance.
The spiral continued in the first two months of 2009, as the portfolio plunged 17 percent more, to $14.3 billion. That, at least, was a slightly better performance than Oregon's benchmarks.
All of which means results have been dismal, whether your strategy was small cap, large cap, growth, value, active or passive.
Performance has been so bad that the five-member citizens council that oversees the Public Employees Pension Fund's investments is considering a switch to a less volatile mix of investments, potentially with fewer stocks and more bonds.
The catch: To make up the actuarial deficit of about $18 billion that Oregon's pension system had at the end of February, much of the heavy lifting would traditionally come through U.S. and international stock returns.
Investment returns account for almost three-quarters of the pension system's revenue over time. Stocks make up the largest part of the portfolio. The stock market also drives results in the system's private equity portfolio. As such, stocks form the backbone of the fundamental actuarial assumption in the pension system: that it can earn 8 percent a year on its investments.
If the Oregon Investment Council decides to get more conservative, it is effectively settling on the notion that taxpayers will foot more of the bill to pay off pension benefits over the long run.
No decision will be made for some time. But the state Treasury Department's chief investment officer, Ron Schmitz, notes that 2008 was one of the three worst years in the stock market since 1825. Indeed, this is a worse 10-year period than the Great Depression and on par with the severe recession and oil shock in the late '60s/early '70s and the bank panic and bear market that preceded World War I.
All of which implies, Schmitz said, that either a serious meltdown is still in the offing, or that stocks are "oversold." Schmitz is thinking oversold, and hopes the snapback in March is the first sign that the market is rising from the dead.
"While we could slide more like the '30s, I think the odds are for a more benign environment," he said. Back to the top
Real estate: PERS rises, falls with 82 properties
Though residential real estate loans started this contagion, it's now firmly established in the commercial sector, where the bulk of the Oregon pension system's $4.3 billion in real estate investments are planted.
Real estate represented 12 percent of the pension portfolio going into the end of 2008, almost double the average of most state systems. State Treasury officials estimate that the value of the pension fund's real estate investments will be down 28 percent in 2008 when the final numbers are tallied next month.
Oregon's pension money has been put to work in most corners of the industry, from private partnerships that invest in distressed debt and underperforming properties, to publicly traded real estate investment trusts. Almost $2 billion is directly invested in 82 properties, including office buildings, shopping centers and industrial space.
To get a sense of the dynamics at work, consider Cochran Commons, a strip mall outside Charlotte, N.C., that the pension fund bought for $14.5 million in late 2007.
The mall is anchored by a grocery store and includes a dry cleaner, a sub shop and other retailers. Its 66,000 square feet of leasable space is 98 percent occupied, and its value was written up by 1 percent in the third quarter of 2008 to reflect capital improvements.
Charlotte's economy, however, has moved in the opposite direction. Its leading corporate residents, Bank of America and Wachovia, have slashed jobs and are expected to vacate big swaths of office space, the latter after being taken over by Wells Fargo. Home sales are down 32 percent in the metro area. Retail vacancy rates are bumping up, and rental rates dropping.
The result: A year-end appraisal of the shopping center came in at $13.5 million, down 7.9 percent. Because the center was 50 percent debt financed, the total decline in Oregon's equity was 15.8 percent.
"The pricing is going to whipsaw us for a while, but we're not selling," said Brad Childs, the state Treasury's real estate portfolio manager. "If you still have good quality, you ride the (market) down and ride it back up again."
Much of the decline in PERS real estate investments in early 2008 had little to do with real estate fundamentals such as vacancy and rental rates, which were healthy, Childs said. Instead, it was lenders' refusal to extend credit on new deals or refinance old ones.
The liquidity crisis hammered the value of PERS' publicly traded real estate investment trusts by almost 50 percent, led to the collapse of one private partnership in which the pension fund had invested $100 million, and destabilized others.
Now it's all about the economy. Commercial real estate tends to lag the economy. Job growth, for instance, is a leading indicator of office rentals and supports apartment leasing, retail and industrial space. With dismal job numbers rolling in nationwide, 2009 is expected to be another rough ride for the sector.
"As we look at '09, we're going to start seeing the second part of the equation, the fundamental contraction," Childs said.
Most of the properties directly owned by Oregon's pension fund, he said, are in strong markets with stable anchor tenants.
Private partnerships, meanwhile, are more precarious because they are so heavily leveraged. To the extent possible, many of them hope to conserve uninvested capital to backstop their current holdings in case their lenders demand more equity or are unwilling to refinance existing loans when they come due. The result is likely to be lower long-term returns for Oregon, even when markets recover.
"There was no place to hide here," Childs said of the state's real estate holdings. "That's the reality." Back to the top
Private equity funds: A once-smart bet becomes a loser
About one-fifth of the Oregon Public Employees Retirement System fund was invested in so-called private equity funds as of the end of February -- more than double the average public pension system's allocation to that class of investments.
The strategy has made Oregon's pension managers look smart for years. Right now, it's a loser. But state Treasury Department officials are maintaining their faith, even as some pundits warn of private equity implosions to come.
Oregon invested early and often in the first generation of private equity partnerships, which were then more transparently described as leveraged buyouts financed with junk bonds.
Though this corner of the finance trade has gone mainstream, the basic game hasn't changed much since the early '80s: Raise money from investors and buy a mature company, financing the bulk of the purchase with high-interest bonds. Pledge the assets of the acquired company as collateral for the bonds and its cash flow to repay them. Restructure the company to carry the additional debt load, generate maximum cash, and if possible, pay big dividends to the acquirer. At the soonest opportunity, flip the company to new investors for a profit.
For more than two decades, this has been a lucrative strategy for institutional investors like Oregon. Just as the real estate bubble enabled Joe Sixpack to buy and flip homes for big profits using little equity of his own, a fast-rising stock market and easy loan terms fueled private equity partnerships' ability to do the same thing with companies. As long as markets kept rising, profits flowed and the size of the buyouts kept increasing.
Then the economy crashed.
Debt-laden balance sheets, a sour economy and reluctant lenders are just as toxic for companies as they have been for individuals. Some buyout targets are being pushed into insolvency. Moreover, just as the market has gone into the tank, new accounting rules require partnerships to value the companies they've acquired as if they were going to sell them tomorrow.
Oregon's private equity portfolio is chock-full of brand-name partnerships such as Kohlberg Kravis Roberts & Co., Texas Pacific Group and Apollo Investment Corp. As such, it has a stake in most of the biggest -- and many expect the most overpriced -- buyouts of the recent past.
On the other hand, Oregon's longevity in the market is on its side, as a good chunk of its investments are in older partnerships in which companies have already paid down much of the acquisition debt they were saddled with.
KKR, which represents about 30 percent of Oregon's private equity portfolio, marked down the value of its funds by an average of 29 percent in the fourth quarter of 2008. That included hits to its investments in credit card processor First Data Corp., hospital chain HCA Inc. and the Texas utility formerly known as TXU Corp.
Texas Pacific's last two big funds, to which Oregon committed $300 million and $750 million, respectively, were down 20.6 percent and 42 percent in the fourth quarter, according to the Oregon Treasury. That followed the funds' write-off in September of their investment in Washington Mutual after the U.S. government sold WaMu's assets to JPMorgan Chase & Co. Oregon's loss on that deal totaled $30 million.
Jay Fewel, the state Treasury's private equity manager, says Oregon's losses aren't anywhere near as bad as those results suggest. He estimates Oregon's private equity portfolio was down by only 18 percent in the fourth quarter. That's an estimate, as only 60 percent of the partnerships have reported in so far.
Fewel says Oregon's recent private equity investments have been hit the hardest and that some of its older funds have actually marked up the value of their investments at year-end. He also contends that big write-downs such as KKR's are the result of conservative valuations.
"Just because something's been written down doesn't mean it can't recover," he said.
Time will tell. It remains to be seen how many companies will be undermined by the recession, and how that will affect funds' long-term returns.
Taking the long view, Oregon's investment managers emphasize that current markets, and programs like the federal governments toxic asset cleanup, may provide a good buying opportunity. "The wild card is the economy itself," Fewel said. "The longer the economy struggles, the more the likelihood of further casualties."
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