Reverse Asset Bubbles

We have written before many times about the accident waiting to happen in many underfunded state retirement funds. One of the ones we mentioned was Illinois. Victims of poor government stewardship, political spendthrifts and the last several years NIRP and ZIRP courtesy of  feckless central bankers, it's an ugly scene. One of the problems is another lowering their expected return on pension investments. Just wo years ago they lowered their expected return and are now abut to invoke another one.

Here's an excerpt from zerohedge.com/news/2016-08-23/illinois-warns-crippling-tax-hikes-devastating-impact-if-largest-pension-fund-admits.

Defined Benefit Pension Plans are, almost by definition, a ponzi scheme. Current assets are used to pay current claims in full in spite of insufficient funding to pay future liabilities: classic Ponzi.  But unlike wall street and corporate ponzi schemes no one goes to jail here because the establishment is complicit.  Everyone from government officials to union bosses are incentivized to maintain the status quo - public employees get to sleep better at night thinking they have a "retirement plan," public legislators get to be re-elected by union membership while pretending their states are solvent and union bosses get to keep their jobs while hiding the truth from employees.
We even published a note several weeks ago titled "Establishment Tries To Suppress "Dissident Actuaries" Explosive Report On Public Pensions," which pointed out that the American Academy of Actuaries and the Society of Actuaries killed a report that would have warned about the implications of lowering long-term expected returns on pension assets.  Apparently the truth was just too scary.
Similarly, Janus' Bill Gross has been warning of the unintended consequences of low interest rates for years, and reiterated his concerns to Bloomberg recently:

Fund managers that have been counting on returns of 7 percent to 8 percent may need to adjust that to around 4 percent, Gross, who runs the $1.5 billion Janus Global Unconstrained Bond Fund, said during an Aug. 5 interview on Bloomberg TV. Public pensions, including the California Public Employees’ Retirement System, the largest in the U.S., are reporting gains of less than 1 percent for the fiscal year ended June 30.

Two weeks ago, we decided to take a look at what would happen if all federal, state and local pension plans decided to heed the advice of Mr. Gross. As one might suspect, the results were abysmal.  We conservatively assume that public pensions are currently $2.0 trillion underfunded ($4.5 trillion of assets for $6.5 trillion of liabilities) even though we've seen estimates that suggest $3.5 trillion or more might be more appropriate.  We then adjusted the return on asset assumption down from the 7.5% used by most pensions to the 4.0% suggested by Mr. Gross and found that true public pension underfunding could be closer to $5.5 trillion, or over 2.5x more than current estimates.  Others have suggested that returns should be closer to risk-free rates which would imply an even more draconian $8.4 trillion underfunding.  


This is the kind of thing that should tell you, if it hasn't already, put your faith in politicians and government bureaucrats at your own peril. These are assets bubbles in reverse, nevertheless caused by bankers, and when they unwind will make lots of folks poorer.