Wednesday, December 30, 2009

Oh Dear, CalPERSfornication Goes Global!

A couple of days ago, Jack Dean of Pension Tsunami posted a link to an article by Arleen Jacobius of Pensions & Investments, How CalPERS strategy backfired (hat tip, Bill Tufts):

Behind CalPERS' staggering real estate losses lies a strategy that took on too much risk and lacked adequate oversight.

Once the fund's star asset class, the real estate portfolio of the $201.1 billion California Public Employees' Retirement System lost nearly half its value during the one-year period ended Sept. 30. The fund's real estate consultant, Pension Consulting Alliance Inc., predicts losses will continue for at least another year.

At the heart of the problem is a freewheeling approach that took on massive leverage, gave enormous discretion to staff and experienced poor timing with its investments.

The decision-making process and risk management need to be much more rigorous, acknowledged Joseph A. Dear, who joined CalPERS as chief investment officer earlier this year. The control over leverage was not as robust as it needs to be, he added. The system will focus more on income-producing, less risky core investments in the future, he said.

“We're inclined toward investment vehicles where we have control,” Mr. Dear said. “This does not rule out fund investing,” he added.

“Hindsight suggests that a large number of CalPERS' real estate investments were extraordinarily ill-timed and inadequately underwritten,” said Stuart Gabriel, professor of finance and director, UCLA Ziman Center for Real Estate in Los Angeles. Mr. Gabriel is not connected with CalPERS.

In recognition of the portfolio's problems, the CalPERS board has imposed new limits on staff's independent investment authority, system officials are revamping its $13.5 billion portfolio and they might ax some of the fund's roughly 70 external real estate managers. (Already, MacFarlane Partners has resigned its account after a nearly $1 billion failed land deal.)

What went wrong?

Just more than two years ago, CalPERS' real estate portfolio was valued at $20.1 billion and staff estimated it would grow to $30 billion over the next five years.

What went awry? In the first half of this decade, when the real estate market was soaring, CalPERS began selling off its least risky, higher-income-producing core properties and shifting the portfolio emphasis to non-core, riskier investments. In particular, the system went after value-added real estate, taking on a bit more risk in the major property types, hotels, student and senior housing, and investing in opportunistic transactions, those taking on the most risk and leverage, according to CalPERS' 2007 strategic plan for real estate.

Some 61% of the portfolio now is in non-core investments as of June 30, the most current information available. So far, some of these strategies have been the worst performers. For example, the system's California Urban Real Estate portfolio lost 40.9% for the quarter and 56.7% for the year, ended June 30. Senior housing dropped 68.2% for the quarter and 71.9% for the year.

In addition, the 2007 strategic plan calls for increasing the portfolio's international exposure to 50% of the portfolio, with a range of 10% to 60%. CalPERS is expected to retain that global focus.

CalPERS is a global investor, Mr. Dear said. “We look worldwide for the best opportunities,” he said. “Some are in California and some are worldwide.”

In short, real estate's role in the portfolio morphed from one of adding diversification — cushioning the impact of volatility in other asset classes — to a “return enhancer.”

CalPERS focused the real estate portfolio on riskier, non-stabilized (meaning properties that were not fully leased or needed some improvements) and non-income-producing properties that were highly leveraged, according to a report by Portland, Ore.-based Pension Consulting Alliance, which has been the system's real estate consultant for years.

The fund also increased leverage across the portfolio.

According to definitions in CalPERS' 2007 strategic plan, core properties, which include real estate investment trusts and substantially leased properties, had up to 50% leverage; value added investments, which require some improvements, could have 50% to 70% leverage; and opportunistic, such as development, could include 70% or more leverage.

But CalPERS' problems didn't stop there. The board delegated enormous authority to its senior investment officer for real estate and to its CIO to invest billions without board or investment committee oversight.

By February 2007, the senior investment officer for real estate could invest up to $1.8 billion in a single deal with an existing manager in a core property and $2.7 billion if the chief investment officer also approved the deal. The senior investment officer could invest close to $900 million with a manager new to CalPERS in a core property and around $450 million in a non-core property such as housing, senior housing, REITs or natural resources.

This meant that very few deals needed board approval.

What's more, the fund did not begin an external due-diligence process, which it has had in its private equity portfolio for years, until January 2008, according to a December 2009 investment activity report.

Damage control

CalPERS was not alone. Between 2005 and 2007, many institutions sold off core real estate holdings and invested in riskier investments, such as opportunity funds and overseas properties, said Dennis Yeskey, senior adviser to AlixPartners LLC, a Detroit-based restructuring firm. Alix Partners does not have a relationship with CalPERS.

“It's a boom-and-bust scenario. During the boom they (institutional investors) invest in more managers and more product types, and there's a bust,” Mr. Yeskey said. “Then they do damage control and consolidate managers.”

And when things went bust, they did so in spectacular fashion. In some cases, CalPERS defaulted on loans, returning properties to the lenders.

Among the deals that have gone sour:

• In October, CalPERS real estate manager PageMill Properties LLC missed a $50 million mortgage payment to Wells Fargo Bank on rent-controlled low-income housing in East Palo Alto, Calif. CalPERS' $100 million investment would be lost if Wells Fargo forecloses.

• In July, CalPERS and joint venture partner CommonWealth Partners LLC defaulted on a mortgage on an office building in downtown Portland, Ore.

• Also in July, the system, in a joint venture with Hines, also defaulted on a $152 million mortgage on Watergate Office Towers in Emeryville, Calif.

• CalPERS faced its biggest loss in a core strategy separate account relationship with CalEast Global Logistics, run by LaSalle Investment Management. The portfolio had been valued at $3.8 billion in the first quarter, but its value fell to $1.52 billion by the end of June 2009.

• In June 2008, LandSource Communities Development LLC filed for Chapter 11 voluntary bankruptcy protection and CalPERS ended up losing its roughly $1 billion investment in the venture.

• CalPERS in the fourth quarter of 2006 invested $500 million in Peter Cooper Village and Stuyvesant Town, a giant middle-class housing development in New York. Tishman Speyer Properties and its partner, BlackRock Inc., bought the development in 2006 for $5.4 billion; it is now valued at roughly half that amount. Tishman Speyer and BlackRock are on the verge of defaulting on their loans.

During the past two years, real estate went from being CalPERS' best-earning asset class — pulling in a one-year return of 14.8% and a three-year annualized return of 26.8% as of June 30, 2007 — to becoming a drag on CalPERS' total portfolio. The real estate portfolio lost $4.2 billion of its value between the first and second quarter of 2009 and $8.6 billion in the 12 months ended June 30.

Policy revamp

CalPERS staff, board and consultants are now weeding through its battered real estate portfolio to determine which properties and managers to keep. Some managers will be terminated outright, but others will be instructed to wind down or sell off their properties and quietly fade away, sources say.

“We're systematically restructuring the portfolio, reducing risk (and) leverage, and are reporting the results of independent appraisals that we required,” wrote CalPERS spokesman Clark McKinley, in an e-mail response to questions. “We're making investment decisions based on a rigorous process in the best interests of CalPERS members and not throwing good money after bad.”

The CalPERS board has revamped its real estate policy, adding stricter controls and oversight that some observers contend should have been in place all along. It has gotten independent appraisals.

It is working toward restructuring the portfolio in stages, starting with relationships such as separate accounts and direct investments, in which CalPERS has most control. The first of three phases could be completed early next year, Mr. Dear said.

This restructuring includes looking at the terms and conditions in all of its current investments, he said. That includes such things as fees, profit split and better alignment of interests, he said.

“Some managers will continue. Some won't,” Mr. Dear said.

The board also pulled back, at least for the next three to five years, the authority it had given to staff to make investments on their own. This discretion has been suspended for new managers and drastically slashed for existing ones. There is now an annual delegation limit of 20% of the real estate policy target for core to existing managers and 5% for non-core or riskier investments, and limits the total amount of real estate assets that can be allocated to one manager to 20% for core and 10% for non-core.

The system is also clamping down on the authority it had delegated to the senior investment officer and CIO to borrow, manage, retire and dispose of debt financing in the portfolio. For example, before a recent policy change, the senior investment officer could commit debt financing of up to 5% of the real estate policy target amount without oversight for a new manager and up to 10% for an existing manager. The CIO could commit up to 15% of the real estate policy target with an existing manager.

CalPERS about three months ago suspended the senior investment officer's authority to commit up to 5% of the real estate target to a new relationship and drastically reduced the senior investment officer and CIO's authority to invest with existing managers without investment committee oversight.

The fund has now gone full circle, focusing on “lower risk, income-producing opportunities,” Mr. McKinley wrote.

What went wrong at CalPERS went wrong pretty much at every major public pension fund which took on increasingly riskier bets to enhance their returns (without proper oversight). I am not exaggerating when I tell you I've seen it all. You name it, and I've seen it at these large pension funds. The stupid risks that were taken with hard earned pension contributions is borderline criminal. At a minimum, it was fiduciary negligence at its worst.

The cozy relationships that developed between senior investment officers and external managers were often overlooked by boards who were not conducting proper oversight of their senior pension officers. When there is big money involved, a lot of people tend to bend the rules and set themselves up nicely for life after the pension fund.

Go back to all the major U.S. and Canadian pension funds to see where many senior officers have landed after they ran billions at the public funds they worked for. In the U.S., there are rules against joining a private fund you allocated money to (minimum three years). Not in Canada, where I know of a few senior pension fund managers in the private markets that set themselves up nicely with the private funds they allocated to.

Disgust doesn't begin to convey the feelings I have for these pension sharks. They are unscrupulous weasels who should be paying back all the bonuses they received after taking on excessive risk to beat their bogus private market benchmarks.

No, what happened at CalPERS grabs the headlines, but reckless greed is endemic and pervasive in the wider pension industy. And as long as governance remains weak, this type of nonsense will continue, putting hard earned pensions at risk. Enough is enough already.


Some excellent feedback from a wise senior pension fund manager:

The presumption is that better "governance" would mean these investments wouldn't have been made. Wrong. The overseers wanted to up the risk, because more risk means more reward, right? Oversight in the US means massive consulting fees, and those consultants are not accountable to anyone, but themselves as relates to fees.

Watch what you wish for. The pension sharks will be replaced by board cronies and their consultant enablers, and you will never know who actually makes an investment decision.

The solution is to not have mega pools of capital, let a multiplicity of governance approaches prevail. The mandates are too big, and are fundamentally ungovernable.

Tuesday, December 29, 2009

A Crisis in the Making?

On Monday, the Montreal Gazette published its first of three editorials, Pension anxiety: a crisis in the making:

Christmas is over, and Boxing Day, too, and grim reality will return with the mail: credit-card bills and other evidence of our recent financial folly. New Year's Day will open RRSP season, when we're urged to invest for retirement.

There's a new anxiety about retirement in many Canadian households. After the investment tumult of the last couple years, Canada's greying population is coming to realize that "the golden years" may be turning to dross.

Today, we begin a three-day series of editorials on Canadians' pensions. Below, we outline the problem. Tomorrow, we'll look at some proposed remedies. And Wednesday we'll suggest where the national debate should go from here.

Typically, Canadians have three sources of money for retirement: government pension, workplace pension and private savings. But government pensions are not generous, workplace pensions cover too few of us, and private saving just isn't happening:

Government: For 2010, maximum payments under the Canada or Quebec Pension Plan plus federal Old Age Security will be under $1,500 a month.

Workplace: 11 million Canadians in the private sector do not have company pension plans. Among those who do, "defined benefit" plans, which put investment risk mainly on the employer, are dwindling away. One recent survey said 59 per cent of employers plan to reassess pension costs, and 43 per cent hope to reduce costs for retiree health benefits.

Private: Canadians use less than 10 per cent of the total "room" we have to invest in Registered Retirement Savings Plans, although RRSPs allow us to save on income taxes while saving for retirement.

Canadians are outliving our pensions. Life expectancy at birth, 77.8 years in 1991, is now 81.9 for men and 85.1 for women. Each year now, a lower proportion of Canadians will be working and paying into the Canada and Quebec Pension Plans, and a higher proportion will be retired and drawing money. By 2030, one-quarter of Canadians will be 65 or older. Something will have to give.

Fortunately, those who monitor these things - actuaries, union officials, professors, some politicians - are coming up with various ideas about how to deal with all this.

But our political leaders are less than eager to wade into this swamp. Meeting in Whitehorse this month, Canada's finance ministers accepted a report from prominent economist Jack Mintz, who said Canada's pension system is working fine. It's a view only an actuary could love: Mintz conceded that over half of private-sector workers lack employer-backed pension plans. The finance ministers just shrugged. "It's certainly not a system in crisis," said Ontario's Dwight Duncan.

They gave less credence to another report, commissioned by Duncan, which warned again about private-sector workers without company pensions, and said a "significant minority" of middle- and even upper-class workers will find themselves much poorer in retirement.

No crisis? If it's not a crisis, it's at least a problem growing toward crisis status. Tomorrow, we'll look at some of the proposed solutions.

On Tuesday, the Gazette published the second editorial, No shortage of ideas on how to fix pensions:

Yesterday we outlined the dark clouds gathering around the pension prospects of Canada's aging workforce. Today we'll survey some of the numerous proposals coming from all sides.

In a field with little consensus, one point goes unchallenged: Governments don't have money to sweeten the pot. With tax revenues down and deficits up, governments may change the rules on pensions, but funding will have to come from employers and employees, not taxpayers.

This being Canada, the provinces and Ottawa will have to co-operate on nationwide reform. As it happens, the governments of British Columbia and Alberta have been leading the charge for a new layer of pension plan. They, and to a degree Saskatchewan, are in loose agreement on finding a way to top up Canada Pension Plan payouts for those who choose - this would be voluntary - to pay more during their working years.

In Ottawa, Liberal chief Michael Ignatieff, often criticized for policy vagueness, has issued clear proposals for something similar, a "Supplementary Canada Pension Plan" through which people could "voluntarily invest extra funds in our trusted national pension."

Ignatieff adds two other proposals: that workers whose pension money is "stranded" by a corporate bankruptcy could have that money managed through the CPP; and that those on corporate long-term-disability pensions should be given preferred status as creditors in any bankruptcy.

Union leaders are calling for even stronger protection for private-sector workers' pensions imperilled in a bankruptcy. It's a hot issue: Many former Nortel employees, for example, are awaiting a sharp cut in pension payments; a nasty shock when you're, say, 75.

Finance Minister Jim Flaherty recently proposed some such improvements, but they would cover only federally-regulated industries, roughly seven per cent of all private-sector workers. Ontario has taken some steps in this direction, too.

Some union leaders want the government to just increase existing pensions. Paul Moist of the Canadian Union of Public Employees, for example, wants C/QPP benefits - and the payroll deductions and employer contributions that pay for them - to be doubled, over a multi-year phase-in period. This is the New Democrats' position, too. Since 93 per cent of employed Canadians pay into the plans, this would be an efficient way to offer better benefits to almost everyone, he says. And the CPP has the advantage of being actuarily stable at least into the 2080s.

The financial-services industry - the companies vying for your RRSP money and the ones which run pension plans for companies - have reacted as you might expect to the idea of a bigger government role. The Investment Funds Institute of Canada, for example, want changes in employer-sponsored pension plans and RRSPs to make these private vehicles more attractive to individuals and companies.

In other words, they want to hold onto their share of the pie. The Canadian Bankers Association says "the savings system in Canada is not broken and there is not a pressing need for a new one-size-fits-all retirement savings program." Sun Life Canada president Dean Connor proposes that unrelated employers be allowed to band together in big new private pension programs with group RRSPs and automatic enrolment, with an opt-out clause. While the CBA is resisting a "one size fits all" federal initiative, Connor warns against the provincial plans B.C. and Alberta are considering, calling them "a patchwork quilt."

Meanwhile the Financial Advisors Association of Canada says an improved CPP/QPP and private-side improvements may both be needed. Other people propose tax changes - more generous RRSP rules, say - to encourage people to save individually for retirement.

There is, then, no shortage of ideas on what to do about pensions. Tomorrow we'll offer our own thoughts.

On that famous Jack Mintz report, please read Jim Murta's actuarial blog where he recently went over the report in great detail. Jim concludes:

So, the conclusion is that “overall, the Canadian retirement income system is performing well, providing Canadians with an adequate standard of living upon retirement.” This is only true if the value of the owner-occupied home is included as an asset. This explains most of the gap in understanding between Dr. Mintz’s report and the views of Canadians. As a policy paper, this one is not of much help. There are too many guesses and assumptions. What is needed is a comprehensive longitudinal study, one that traces what actually happens to retirees’ incomes.

Another expert, Bernard Dussault, Senior Research and Communications Officer at the National Association of Federal Retirees, and the former Chief Actuary of Canada, shared these thoughts with me following the Whitehorse meeting:

Two years ago, four provinces were most concerned with serious pension issues and launched 3 provincial commissions.

Last year, the federal government was much concerned with similar pension issues and launched two series of consultations.

Through the Jack Mintz's and the Bob Baldwin's reports, these 5 governments are now being told that the status quo is an option. I look forward to see how these governments' reaction. Here is mine.

Both reports refer to Statistics Canada's figure to the effect that the rate of poverty among Canadian is only 4%. But neither report refers to the GIS take-up rate of 35%. Yes, 35% of Canadians over age 65 receive a GIS benefit.

A perhaps surprising extreme example of such recipient is a person receiving the maximum CPP retirement pension (about $11,000) and the OAS benefit (about $6,200) but no other income. That person is entitled to a GIS benefit of about $1,500 (i.e. 50% of the difference between about $14,000 and $11,000). Disregarding any provincial GIS supplement, as the case may be, e.g. Ontario's GAIN program, this person's total retirement income therefore amounts to about $18,700. As this is about the threshold of poverty for someone living in a large municipal area, this extreme case is at the verge of falling (if not already already) in the category of poor persons. As most cases are not extreme cases, the poverty rate is in all likelihood much closer to 35% than 4%.

Obviously, the status quo is always an option, but the recognition of the reality of poverty is not.

I went over some of my thoughts on the Canadian pension debate roughly two weeks ago. With all due respect to Jack Mintz, I'll take the expert opinions of Jim Murta and Bernard Dussault over his on the pension crisis. If politicians prefer to avoid discussing this issue, they're only delaying the inevitable and mark my words, this issue will come back to haunt them.


On Wednesday, the Gazette published its third editorial, Pension woes won't be easy to fix, stating that the problem isn't in public pensions but private pensions. I beg to differ. The pension crisis may touch the private sector first, but it's only a matter of time before it reaches the public sector. Importantly, if we don't fix the major governance gaps at the large public pension plans, another disaster similar or even worse than 2008 will occur. When it comes to fixing pension woes, tough political decisions will need to be taken and stakeholders need to significantly improve the governance at major public plans.

Also on Wednesday, Daniel Leblanc and Bill Curry of the Globe and Mail report that Ottawa targets public service pension plan for cutbacks. A proposal is circulating to put an end to early-retirement provisions for new hires:

The Conservative government raised the possibility this month of going after the bureaucracy's pension plan as it looks for ways to deal with a ballooning deficit.

But senior civil servants are also concerned that too many bureaucrats retire in their mid-50s, causing staff shortages that are set to worsen in coming years.

Any major change to the Public Service Superannuation Act, however, will be stiffly opposed by unions, which are trying to contain the growing criticism of their members' plans in an era of dwindling private-sector pensions.

One of the most controversial aspects of the federal pension plan is the ability to retire with a full pension at age 55, after 30 years of service.

Federal officials expressed concerns that the provision is “reducing the pool of staff with experience,” with half of the executives in government eligible to retire by 2012.

Want to take a stab at which issue will become the next politcal powder keg in Ottawa and around the world?

Monday, December 28, 2009

CPPIB Joins ADIA to Bid on EDF Energy Assets

Nick Clark of the Independent reports that Abu Dhabi in for EDF asset:

The auction for EDF Energy's electrical distribution business is expected to heat up after news emerged that Abu Dhabi, which has run the slide rule over the asset in the past, has held talks over a potential £5bn joint bid.

The Abu Dhabi Investment Authority, the Gulf state's sovereign wealth fund, is understood to have joined the Canadian Pension Plan in a joint bid for the business, which the French energy group put on the block two months ago. Goldman Sachs and Lexicon Partners are understood to be involved in an advisory capacity to the consortium.

EDF, which is majority owned by the French government, revealed in October that it was considering its "ownership options" for the electricity distribution business in the UK. At the time it said it "regularly receives spontaneous expressions of interest". The group, which hired Barclays Capital, Deutsche Bank and BNP Paribas to oversee the sale, declined to comment.

Eric Lam of the National Post reports CPP eyes joint bid for Europe's EDF Energy:

The Canada Pension Plan Investment Board is planning to make a joint bid for EDF Energy, the giant U.K. electricity distribution network owned by France's Electricité de France, reports said Monday. The deal could be worth US$7.9-billion, the reports said.

The potential deal would be made in partnership with Abu Dhabi's sovereign wealth fund with Goldman Sachs advising the bidders, Dow Jones reported after news of a possible bid appeared on the French website Wansquare.

Calls to the CPPIB were not returned Monday.

The CPPIB has had its eye on EDF Group, the parent of EDF Energy, for a while. The fund has held 104,000 shares in the French company since March.

EDF Group, one of the largest energy companies in Europe, said in October it was looking to reduce its debt by at least 5-billion euros by the end of 2010 by exploring "ownership options" for EDF Energy, which provides electricity to more than 5.5 million people and businesses in London as well as southern and eastern England.

This would not be the CPPIB's first foray into European investments. And if the reports are confirmed, it would appear to be part of its plan to take a more aggressive stance on worldwide infrastructure acquisitions.

Last week, the CPPIB picked up a 50% stake in Scotland's second-largest shopping mall, the Glasgow Silverburn Mall, for about $250-million. This increased the CPPIB's real-estate assets in the United Kingdom to more than $1-billion, the fund told the Financial Post at the time.

Two days after that, unitholders of Livingston International Income Fund approved an amended joint offer the investment board made with Sterling Partners for the trust for about $324.4-million. The pair had initially agreed to a purchase price of about $273-million in October. Livingston is a trust that owns Livingston International Inc., a leading North American customs, transportation and logistics services company.

In November, the CPPIB partnered with TPG Capital to pick up IMS Health, a leading market-intelligence provider for pharmaceutical and health-care businesses, in a deal worth $5.4-billion.

It was also part of a group that purchased a 70% stake in eBay Inc.'s Skype communications unit for about $2.1-billion in cash and debt in the same month.

Meanwhile, the CPPIB and Ontario Teachers' Pension Plan made a joint bid for Australian toll-road company Transurban Group at the end of October worth A$6.77-billion ($6.3-billion) that was ultimately rejected.

In August, the fund committed to joint real-estate and logistics ventures in Brazil and China.

And in June, the CPPIB shelled out about $1.52-billion for Macquarie Communications Infrastructure Group.

The CPPIB, founded by an act of Parliament in 1997, invests pension assets that are not being used to pay the benefits of 17 million Canadians. As of September 2009, the investment board's portfolio was worth $123.8-billion.

CPPIB has been very busy snapping up private market assets. Most of these deals are co-investments with private equity partners. Goldman and Lexicon Partners will rake in huge advisory fees on the EDF Energy Energy deal.

While CPPIB continues its private assets shopping spree, stakeholders need to be made aware of all the gamut of risks. Given it's profile, CPPIB can take on illiquidity risk, but these deals carry other risks that must be appropriately reflected in the benchmarks governing CPPIB's private markets.

Unfortunately, without proper disclosure, we simply do not know all the risks and costs associated with these deals. For example, what are the advisory fees and how will they be paid? Are regulatory and other risks carefully assessed? If it's a co-investment, how will performance be evaluated and attributed?

Large buyout deals capture the big headlines but you need to look at the risks associated with these deals and how these assets will be benchmarked for compensation purposes. These might be good deals but stakeholders need to keep their eye on the ball, making sure the benchmarks reflect the risks associated with these deals.


Erik Andersen asks the following question:
Global Infrastructure Partners completed the purchase of Gatwick Airport earlier this month. It was previously reported that the CPPIB was to be a partner in this investment. Has the CPPIB indeed invested with Global and in what amount?

Saturday, December 26, 2009

Lessons From a Tsunami Survivor

I would like to follow-up on my last comment on Katie Piper's Christmas message with another inspirational story from yet another beauty who survived a harrowing ordeal five years ago.

ABC's David Muir reports on Petra Nemcova: Healing Five Years After the Tsunami:
Nearly five years ago Petra Nemcova was swept from her hotel room when a tsunami struck Thailand. Now the 30-year-old model is helping to heal others by rebuilding schools for the children who lost everything, not just in the deadly 2004 tsunami but in natural disasters around the world.

"Really, honestly, what I'm doing now, being able to improve, and better lives of children, that's what I always wanted to do," Nemcova said.

Four months after Nemcova clung to a tree for eight hours to save her life she went back to visit the tsunami zone. She said she would never forget the faces of the children.

"They lost their parents or their brothers and sisters. They didn't have anywhere to go. They didn't have any stability. When you looked at those children they didn't actually look at you. ... They looked through you. And it was this look without hope," Nemcova said.

Nemcova founded the Happy Hearts Fund to build schools for children in areas ruined by natural disasters.

Five years later, the foundation has expanded and has provided help to children in eight different countries.

The team renovated and rebuilt the Chao Thai Mai School in Thailand.

They also built a primary school, helping a total of more than 1,500 children in Thailand.

The foundation built one primary school and 33 kindergartens in Indonesia, helping nearly 2,000 children. Indonesia was struck not only by the 2004 tsunami but by a devastating earthquake in 2006.

In Peru, which suffered a deadly earthquake in 2007, Nemcova helped rebuild two schools that served more than 3,000 children.

PHOTO Petra Nemcova is helping to heal others by rebuilding schools for children who lost everything after natural disasters.

Petra Nemcova works to heal others by rebuilding schools for children who lost everything after natural disasters. In total, the Happy Hearts Fund built or repaired dozens of schools around the world that helped nearly 12,000 children pursue an education.

Click here to visit the Happy Hearts Fund Web site.

As the fifth anniversary of the tsunami disaster on Dec. 26 approaches, Petra said she wants to remind everyone of the lesser-known disasters, the children whose faces we don't always see and lives that were lost.

Petra is a stunningly beautiful lady but her inner beauty is what I find most impressive. Far from being bitter and withdrawn, she chose to move on and help those children that were left orphaned after that tsunami devastated their lives. You can watch her story by clicking here.

I would invite my readers to donate whatever they can to Petra Nemcova's Happy Hearts Fund as well as the Katie Piper Foundation.

I know it's Boxing Day and many of you are all tapped out, but it's important to take a step back and see where your dollars can serve the best interests of our larger global community.

Thanks again, and have a happy and safe holiday season.

Friday, December 25, 2009

Katie Piper's Christmas Message

The Telegraph recently published an article, Appreciate beauty, acid attack victim tells Christmas viewers:

The model and aspiring TV presenter before the attack has received thousands of supportive messages from the public.

In her message, appeared in a Cutting Edge documentary titled Katie: My Beautiful Face this autumn -she reflects on her progress over the last year and how strangers' words of kindness have helped her to move forward.

Piper was left fighting for her life after former boyfriend Daniel Lynch raped her and then arranged for another man to hurl the corrosive liquid.

The acid burned through all four layers of skin on her face, some spilling down her throat, and she was left blind in one eye.

Piper has undergone more than 30 operations on her face and throat.

But she tells how it took the tragedy for her to reassess her ''self-obsessed'' life.

Piper says: ''This year I wanted to give a Christmas message to everybody out there who might have had a Christmas like I did last year.

''In March 2008 I was attacked with acid and left fighting for my life. I was at an all time low, too scared to leave the house.

''I didn't see how things could ever get better.''

She says that before the attack she would go home to her parents on Christmas Eve and: ''Have a few drinks, see them, spend Christmas Day with them chilling out and go home on Boxing Day.

''My life before was very self-absorbed, self-obsessed and it took a tragedy for me to reassess my life and how I felt and what I thought was important.''

Lynch sent Piper a message on Facebook and the pair began dating, but the martial arts fan quickly became obsessively jealous. He raped Piper in a London hotel room.

Lynch refused to let her return home for hours afterwards and telephoned her, insisting that she visit an internet cafe near her flat and mysteriously asking what she was wearing.

This was so that he could direct Stefan Sylvestre to throw acid over her.

In the wake of the attack and only able to communicate by writing, she told her mother Diane ''kill me''.

Piper decided to go public to raise awareness of the plight of burns victims.

She says in her message: ''Don't wait 'til there is tragedy in your life. Don't wait 'til you lose somebody.

''Don't wait until it's too late. Appreciate the beautiful things and the beautiful people that you have in your life now.

''Earlier this year I decided to make a documentary telling my story.

''The night before it went out I was so nervous, frightened that when people see me they might think that I was a freak. Overnight my life changed completely.

''I was able to move forward instead of looking back.

''To see that over 200,000 people have posted encouraging, loving messages of support on the internet, it's just simply amazing. It's such a great feeling to feel so supported by people.

''My Christmas message would be to tell people that I used to hide away and be ashamed of how I looked, frightened of people's reactions and if people are doing that or feel that way now, I would urge them not to because they don't have to feel like that and you can become accepted, you can regain the confidence.

''And for the people that need to do the accepting, that maybe they freak out when they see somebody who's different, you absolutely don't have to.''

In court Lynch, who was jailed for life with a minimum of 16 years and Sylvestre who was sentenced to life with at least six years, were told by the judge that they were ''the face of pure evil''.

Piper says of the response she has received: ''All these letters... have given me so much confidence, a massive amount of confidence and changed the way I am living my life and I really hope that it can show other people that these aren't just for me, these are for everybody who's feeling the way I once felt.

''Even when you think things can never move forward and you feel so low there's always a way out and I never thought that I'd be sat here saying this, never.''

Piper has also launched a charity, the Katie Piper Foundation, to help other burns victims. To subscribe or to make a donation go to

As you gather around this holiday season, keep in mind that many people aren't as fortunate as you. Katie's message is simple and powerful. Her unbelievable courage exemplifies what the true meaning of Christmas really is. It's not about gifts, food, and superficial things. It's about peace, hope and perseverance. It's about cherishing the beauty of life and those we love all around us.

I wish you all a Merry Christmas, Happy Holidays and a Happy New Year. I will be posting on and off, but I just wanted to send you my best wishes.

***UPDATE: ABC/20/20***

ABC's 20/20 covered Katie's courage in overcoming this horrific attack in Model's Dream Derailed by Acid Attack. Please watch it, she's an incredible young lady. And don't forget to donate to her foundation.

Thursday, December 24, 2009

Betting on Big Rise in Yields?

Henny Sender of the FT reports that top hedge funds bet on big rise in yields:

The recent rise in long-term US interest rates comes as good news for several leading hedge fund managers, including John Paulson, who have positioned their trading books to benefit from higher yields on US Treasury securities.

Mr Paulson, who made big gains earlier this decade by betting against the subprime mortgage market and whose firm, Paulson & Co, manages $33bn, has said he believes that government stimulus efforts would inevitably lead to higher inflation and a corresponding rise in rates.

“It will be difficult for the government to withdraw the economic stimulus,” Mr Paulson said in a speech. “An increase in the monetary base leads to an increase in the money supply, which leads to inflation.”

Bond prices fall as yields rise, and Mr Paulson told the Financial Times last week that he has been hoping to benefit in the Treasury market by buying options that would become profitable if rates headed higher. TPG-Axon’s Dinakar Singh has been making similar options trades, according to a person familiar with the matter.

Julian Robertson, the hedge fund manager, has pursued a related strategy, hoping to benefit from a bigger difference between short-term and long-term interest rates, known as a steeper yield curve, a person familiar with his trades said.

The yield on the 10-year Treasury, which hit a crisis low of 2.055 per cent last year, has moved from 3.2 per cent last month to 3.75 per cent on Tuesday.

Hedge fund managers, however, have been hesitant to engage in short sales of Treasury bonds to profit from the rising yields – and falling prices – because of the Federal Reserve’s heavy involvement in the market. This has led some to buy options – dubbed “high strike receivers” – that would enable them to profit from sharply higher Treasury yields, hedge fund managers say. These trades, which are relatively cheap to execute because they are so out of the money, are based on the thesis that yields could hit 7 or 8 per cent.

“If they are right, and the world ends, they will make a fortune,” said one fund manager who is sceptical of the idea. “If they are wrong, they haven’t lost much.”

Some traders are cautious because many peers lost large sums betting that rates would rise in Japan in the 1990s – as yields fell to less than half a percentage point. The trade was termed the “black widow” because it left so many victims.

“Nobody understood the extent of deflation and economic weakness in Japan,” said Dino Kos of Portales Partners, a research consultancy, who was then a Fed official. “More money was lost on that trade than on any other single trade. Everyone piled in when rates were at 3 per cent and then at 2.5 per cent and then at 2 per cent.”

So is it time to place big bets on rising yields? I could easily see a backup in yields in the near term as economic reports surprise to the upside, but I don't believe that bonds have entered a long-term secular bear market. I think the hedgies are right, best to play interest rate directional calls though options.

Also, given the increase in liability-driven investing by pension funds worried about their funding status, there is an upper cap on bond yields. I don't know what the exact magic number is, but at a certain level (say 7%), you'll have pensions scambling to lock in rates. Bond bears tend to ignore this when predicting doom and gloom on bonds. All they do is focus on the "pending collapse" of the US dollar, which won't happen.

Tuesday, December 22, 2009

CPPIB Goes Christmas Shopping?

Steve Ladurantaye of the Globe and mail reports that CPP goes shopping:

The Canada Pension Plan Investment Board snapped up a Scottish shopping mall Monday, partnering with an English fund Hammerson on the $479-million deal.

The Silverburn mall, which opened in 2007, is a single-level covered centre anchored by Debenhams, M&S, New Look, Next and Tesco Extra. It provides 94 retail units let to high quality retailers, has an occupancy level of 98 per cent, and an average unexpired lease term of over 12 years. The centre attracts approximately 14 million customers per year.

This transaction represents a unique opportunity to acquire a high quality asset alongside one of the top retail developers and operators in Europe," said Graeme Eadie, senior vice-president of real estate investments for CPPIB. "We are delighted to be partnering with Hammerson as co-investor and manager, given their proven track record in managing similar assets.”

Karen Mazurkewich of the National Post provides more details, reporting that CPP lands U.K. mall in distress sale:

Thanks to a distress sale, Canada Pension Plan Investment Board is a part owner of Scotland's second-largest shopping centre. CPPIB paid about $250-million for a 50% stake in the Glasgow Silverburn mall -- a deluxe retail property that featured 95 stores and 14 restaurants when it opened in 2007.

This latest sale boosts CPPIB's real estate assets in the U.K. to more than $1-billion from $800-million, according to Graeme Eadie, its senior vice-president for real-estate investments.

The U.K. media reported that Silverburn cost a whopping £350-million ($597-million) to build, significantly more than the £297-million CPPIB and its partner, Hammerson PLC, paid to the receiver appointed by the bank to recover its losses from the mall's original owners.

Silverburn's Retail Property Holdings Inc., a unit of Elementary Property Co., went into receivership in July.

"My understanding is our price does not pay the bank back," said Mr. Eadie.

The purchase of the Scottish mall comes almost six months after retail property values ended a 46% slump that had lasted two years. Nevertheless, Mr. Eadie is upbeat about the purchase. "This was built by a private company at the top of the market and over-levered ... but we considered it a good asset. It's fully leased, and our view and Hammerson's view is that the rents are under market, and when the renews come up we will be able to push the rents up."

Another plus is that it was one of the few retail properties on the market that was available in total and, with a footprint of a million square feet, it had major heft.

It comes as little surprise that the first real-estate plays following the economic crisis are in the U.K. "The U.K. market moved down more quickly than the other markets; we've found the bottom now, so there have been more transactions there," said Mr. Eadie.

While the pension fund is still eyeing the U.S. market, and pricing is moving down, he said there is very little being sold there yet.

Unlike Brookfield Asset Management, which bought portions of General Growth Properties' debt and bonds in order to position itself for a piece of the equity, Mr. Eadie said CPPIB is not playing in the debt markets.

CPPIB has direct holdings in three other U.K. properties: an 80% ownership in two office buildings in London and a 50% stake in Whitefriars Quarter shopping centre. Through the Westfield U.K. core shopping centre fund, the pension plan holds interests in four shopping centres in Birmingham, Derby, Northern Ireland and Tonbridge Wells.

Earlier this year, CPPIB's private-equity arm kept busy with its own shopping spree. In addition to purchasing IMS Health, one of the world's leading providers of market intelligence to the pharmaceutical and health-care sectors, with U.S.-based private-equity firm TPG Capital in a deal valued at US$5.2-billion, the pension fund joined forces with U.S. Sterling Partners to buy the Canadian customs brokerage firm Livingston International Income Fund in a deal priced at $273-million. The pension fund also announced in September that it's part of the investor group acquiring a 65% interest in Skype Technologies from eBay in a US$2-billion cash and debt, and snapped up Macquarie Communications Infrastructure Group for $1.52-billion in June.

I have nothing to add on the latest real estate purchase as it sounds like a good deal, especially if retail properties recover in the UK (not sure when this will happen as they are mired in a deep recession).

My only comment is that all these investments in private markets must be carefully evaluated relative to a benchmark that reflects the risks they're taking. And while CPPIB publicly discloses the transactions, they don't bother clearly disclosing their private market benchmarks. Without beating the point to death, this is totally unacceptable and not in accordance with best standards on pension governance.


Laura Chesters of Property Week provides crucial details on the deal, reporting that Hammerson and Canada Pension Plan buy £297m Silverburn. I quote the following:

As revealed by Property Week on 18.11.09 the pair have entered a 50:50 joint venture which has bought Retail Property Holdings, the company that owns the 1m sq ft Silverburn shopping centre, from The Elementary Property Company.

The £297m price equates to £148.5m each. The current gross rental income is £18.4m, representing an initial yield of around 6%, and an equivalent yield of 6.8%. After operating costs, net income will be approximately £17m in 2010. Hammerson
will be the asset manager for the joint venture.

Silverburn opened in 2007 and is anchored by Debenhams, M&S, New Look, Next and Tesco Extra. Its 94 retail units have an occupancy level of 98%, and an average
unexpired lease term of over 12 years.

Hammerson and CPP believe the centre has rental growth, asset management and development opportunities. Average prime zone A rents are £140/ sq ft, with overall rents passing estimated to be up to 20% below current market rental levels. First rent reviews at the centre start from 2012.

There is also potential to extend the centre by around 100,000 sq ft and the purchase of the centre includes also includes 743,000 sq ft of development land opposite.

Hammerson will fund the acquisition from existing bank facilities which have a margin of 37.5 basis points over LIBOR.

I received this comment from Erik Andersen,a BC economist:

News Item today (Globe and Mail); CPP IB is investing CDN $252 million to own a 50% interest in a shopping mall in Scotland. Gross rentals are reported to be $31.3 million, or 6.2% on the total price of $505 million.

When one removes operating expenses (particularly the management expense to be charged by co-investor Hammerson) what will be left is certainly going to be close to a zero return.

So once again the CPPIB is the "investor of last resort" where the return on investment must be almost zero; then there is the risk of owning real estate in a relatively poor part of the UK and to add further insult to injury we Canadians are exposed to currency risk.

The sellers must just love Canadians these days as we continue to re-affirm that the "greater fool" theory is alive and well.

I'm not sure how he calculates a return close to zero since even after expenses, yield looks over 5%. As for currency risk, it comes with all foreign investments. But Erik did mention that this is "gross rental income" and there must also be property taxes to pay, utility bills and maintenance and repair of the asset.

Another buddy of mine who used to work in real estate sent me this comment:

I believe it is too early to invest in equity in retail RE. This said it is possible to find very good deals. At 6% of return, this is not enough. It is not because you have leases that you will have revenues... companies can go bankrupt and vacate. The current normal RE wisdom is to invest in debt and let others waste their equity until they can not support the asset anymore... then you foreclose the asset by kicking out the owner you become the only one in the equity position. To invest in equity in RE you must be at the bottom of the RE cycle... I am sure that CPPIP is too early for that case.
I think the big gains will come if CPPIB can turn around and sell this property to a greater fool in the next five to ten years.

Mercer’s Little Alaska Problem?

Gretchen Morgenson of the New York Times reports on Mercer’s Little Alaska Problem (hat tip Dan Braniff):
Although it has received little coverage lately, a bombshell of a lawsuit inching its way through the superior court of Alaska has revealed the financial strain visited on state workers there and promises to have ramifications for public pensions across the country.

The Alaska Retirement Management Board, a state agency, filed the suit in 2007 against Mercer, the human resources consulting firm. The lawsuit says that Mercer’s mistakes hindered the ability of Alaska’s retirement system to meet its obligations to former public employees.

Mercer, the agency contends, made multiple errors as the state’s actuarial consultant when it estimated the amounts that two of the state’s retirement plans needed to set aside for health care and pension benefits. The agency seeks damages of $2.8 billion.

Earlier this year, Mercer, a unit of Marsh & McLennan, had asked Patricia A. Collins, the superior court judge overseeing the matter, to dismiss the case. Mercer’s lawyers argued that it did no “compensable harm” or damage to Alaska’s retirement systems.

On Dec. 4, Judge Collins denied the motion and ordered a trial to be held in Juneau next July to determine whether Mercer had harmed the system.

That Mercer erred in its calculations is bad enough — getting such details right, after all, is what the firm advertises as its stock in trade.

But an even bigger grenade dropped earlier this year when the Alaska board, citing depositions of Mercer employees, contended that company executives had known about the actuaries’ errors and covered them up.

If Alaska prevails in court, it could entitle the retirement system to punitive as well as treble damages.

Mercer, with 4,000 employees in 150 offices around the world, concedes that the Alaska case is a threat. In its usual corporate filings, a brief discussion of the case heads a list of risks facing Marsh. It also notes that it has “limited” insurance to cover the costs of an adverse outcome.

And according to Marsh’s most recent quarterly filing, the company has not recorded a liability related to the Alaska case because it cannot determine “that a loss is both probable and reasonably estimable.”

In a statement, Mercer conceded that its error and its failure to disclose it was “a mistake in judgment that Mercer regrets and it is not consistent with the company’s corporate culture.”

Mercer had worked for Alaska since the 1970s. From June 1999 to April 2006, it got $2.5 million for its work on behalf of the Alaska funds. The suit said it billed the plans as much as $430 an hour.

Unlike most public pensions that promise to pay future benefits out of money they hope to earn, the Alaska systems funded health care costs in advance.

As actuary for retirement plans that serve both teachers and other public employees, Mercer had the duty to calculate the plans’ liabilities and determine the employer contribution rates to fund those promises.

But, according to the lawsuit, when Mercer prepared the plans’ 2002 report, it understated their liabilities by as much as $1 billion.

Then, rather than own up to the mistake, Mercer executives covered it up, the documents say. “Following standard Mercer policies designed to prevent clients from discovering Mercer’s errors,” Alaska’s lawyers contend, “Mercer’s actuaries carefully avoided creating a written record of their discussions and calculations, in order, one of them testified, to avoid creating a ‘trace.’ ”

The error that Mercer covered up, according to the lawsuit, occurred in 2002 and involved a “per capita claims cost,” which represented the estimated expenses of providing health care to a retiree. Mercer used one assumption for retirees under age 65 and another, lower estimate for those over 65 because they could tap into Medicare benefits.

But the amount entered into Mercer’s computers for employees of pre-retirement age was $213 less than it should have been. The error understated the amount of liabilities owed by one of the Alaska funds by 10 percent.

A Mercer actuary found the error before the 2002 valuations were to be presented to the Alaska plans and reported it, along with a colleague, to a supervisor. But after several discussions, the lawsuit says, the Mercer executives decided not to tell their client about the error.

One of the Mercer actuaries on the account testified he was “concerned about the ethics of what Mercer was doing by not telling the State of Alaska,” the lawsuit shows. He said that Mercer did not disclose the error because the firm was fearful of being fired. (This happened anyway, in 2006.)

The error was compounded in 2003 because Mercer continued to use an artificially low number for pre-retirement-aged beneficiaries. If the firm had corrected the earlier mistake, an actuary said in a deposition, “It would have been difficult to explain.”

Because of the errors and cover-up, the lawsuit said, Mercer underreported by more than $2.8 billion the contributions required to fund the plans.

Of course, estimating future health care costs is not easy. But the lawsuit details what look like obvious failures by Mercer. For example, Mercer consulted “real-world data” on health care expenses only every five years, a problematic practice given the volatility of these costs.

Mercer also made significant “coding errors” when entering information about the plans into its computer models, the complaint says. It ignored some salary increases for employees as well as survivor benefits, thereby underestimating plans’ liabilities.

The errors emerged in October 2002, when an outside auditor hired by the Alaska funds to examine Mercer’s work delivered a highly critical report on its findings. The lawsuit states that Mercer actuaries attended the meeting where the report was presented and accepted the outside firm’s criticisms.

But a company spokesman said last week that Mercer believed that its error wouldn’t have an impact on contributions to be made by the plans because an Alaska regulation imposed a 5 percent cap on annual contribution rate increases, and Mercer’s recommended rate was already much higher. “Accordingly, Mercer believes that the error had no impact on the plans and that the plans have not, in fact, been damaged,” the spokesman said.

Mercer has had similar problems with other pension clients. Last May, the company paid $45 million to settle a negligence lawsuit filed by Milwaukee’s pension board. Mercer did not acknowledge it was at fault in the matter.

Nevertheless, all eyes are on the Alaska case, because of its size. Indeed, while the suit is pending, actuarial firms are finding it impossible to buy liability insurance against such claims.

“This is the largest case out there in the industry and it could have enormous ramifications if the plaintiff were to succeed,” said Gene Kalwarski, founder of Cheiron Inc., an actuarial consulting firm serving large pension and health insurance funds. “It’s unfortunate that one firm’s behavior, if they are found to be liable, is going to result in other firms being unable to obtain insurance coverage.”

Lewis R. Clayton, a partner at Paul, Weiss, Rifkind, Wharton & Garrison, who represents the Alaska board, said the case illustrates the role an actuarial firm plays in workers’ lives, “and how important it is that actuaries do honest and high-quality work.”

Indeed, about 80,000 workers rely on payments from the retirement systems that have sued Mercer. And the errors made by the firm were a big reason why the Alaska system changed its pension structure, according to people briefed on the discussions.

For all employees hired after 2006, the funds no longer offer a classic pension fund, where retirees receive a specified amount each year. Now those workers receive a defined-contribution plan, similar to a 401(k) account.

Mercer, meanwhile, is learning that age-old lesson: To err is human. To cover up, plain dumb.

To cover up is indeed plain dumb. What in the world were those Mercer executives thinking? That the Alaska Retirement Management Board wouldn't notice their liabilities were off by almost $3 billion? Something tells me Mercer is in big trouble and that actuaries are going to find the cost of liability insurance skyrocketing, if they can get someone to provide it to them.

Sunday, December 20, 2009

The Problem With Economics?

Last Sunday, I posted on Paul Salmuelson's legacy in economics, paying a tribute to a giant in economics. But not every economist shares these views.

On Friday, Paul Krugman referred to Michael Hudson's critical assessment of Samuelson in a recent blog entry, Why economics is the way it is:

A number of people are linking to this reprinted critique of the work of the late Paul Samuelson. I could point out that the critique thoroughly misunderstands what Samuelson was saying about international trade, factor prices, and all that. But there is, I think, an interesting point to be made if we start from this complaint:

Can it be “scientific” to promulgate theories that do not describe economic reality as it unfolds in its historical context, and which lead to economic imbalance when applied?

Actually, there was a time when many people thought that institutional economics, which was very much focused on historical context, the complexity of human behavior, and all that, would be the wave of the future. So why didn’t that happen? Why did the model-builders, led by Samuelson, take over instead?

The answer, in a word, was the Great Depression.

Faced with the Depression, institutional economics turned out to have very little to offer, except to say that it was a complex phenomenon with deep historical roots, and surely there was no easy answer. Meanwhile, model-oriented economists turned quickly to Keynes — who was very much a builder of little models. And what they said was, “This is a failure of effective demand. You can cure it by pushing this button.” The fiscal expansion of World War II, although not intended as a Keynesian policy, proved them right.

So Samuelson-type economics didn’t win because of its power to cloud men’s minds. It won because in the greatest economic crisis in history, it had something useful to say.

In the decades that followed, economists themselves forgot this history; today’s equation-mongers, for the most part, have no idea how much they owe to the Keynesian revolution. But in terms of shaping economics, it was the Depression that did it.

Michael responded to Krugman's post with this reply which I share with you:

Krugman criticized my criticism of Samuelson {1}, referring readers to the UMKC reprint of my Counterpunch article. So I wrote this in response.

I have recently republished my lecture notes on the history of theories of Trade, Development and Foreign Debt {2}. In this book I provide the basis for refuting Samuelson's factor-price equalization theorem, IMF-World Bank austerity programs, and the purchasing-parity theory of exchange rates.

These ideas were lapses back from earlier analysis, whose pedigree I trace. In view of their regressive character, I think that the question that needs to be asked is how the discipline was untracked and trivialized from its classical flowering? How did it become marginalized, taking for granted the social structures and dynamics that should be the substance and focal point of its analysis? As John Williams quipped already in 1929 about the practical usefulness of international trade theory, I have often felt like the man who stammered and finally learned to say "Peter Piper picked a peck of pickled peppers", but found it hard to work into conversation {3}.

But now that such prattling has become the essence of conversation among economists, the important question is how universities, students and the rest of the world have come to accept it and even award prizes in it!

To answer this question, my book describes the "intellectual engineering" that has turned the economics discipline into a public relations exercise for the rentier classes criticized by the classical economists: landlords, bankers and monopolists. It was largely to counter criticisms of their unearned income and wealth, after all, that the post-classical reaction aimed to limit the conceptual "toolbox" of economists to become so unrealistic, narrow-minded and self-serving to the status quo. It has
ended up as an intellectual ploy to distract attention away from the financial and property dynamics that are polarizing our world between debtors and creditors, property owners and renters, while steering politics from democracy to oligarchy.

Bad economic content starts with bad methodology. Ever since John Stuart Mill in the 1840s, economics has been described as a deductive discipline of axiomatic assumptions. Nobel Prizewinners from Paul Samuelson to Bill Vickery have described the criterion for economic excellence to be the consistency of its assumptions, not their realism {4}. Typical of this approach is Nobel Prize winner Paul Samuelson's conclusion in his famous 1939 article on "The Gains from International Trade":
In pointing out the consequences of a set of abstract assumptions, one need not be committed unduly as to the relation between reality and these assumptions. {5}
This attitude did not deter him from drawing policy conclusions affecting the material world in which real people live. These conclusions are diametrically opposed to the empirically successful protectionism by which Britain, the United States and Germany rose to industrial supremacy.

Typical of this now widespread attitude is the textbook Microeconomics by William Vickery, winner of the 1997 Nobel Economics Prize:
Economic theory proper, indeed, is nothing more than a system of logical relations between certain sets of assumptions and the conclusions derived from them ...

The validity of a theory proper does not depend on the correspondence or lack of it between the assumptions of the theory or its conclusions and observations in the real world. A theory as an internally consistent system is valid if the conclusions follow logically from its premises, and the fact that neither the premises nor the conclusions correspond to reality may show that the theory is not very useful, but does not invalidate it. In any pure theory, all propositions are essentially tautological, in the sense that the results are implicit in the assumptions made. {6}
Such disdain for empirical verification is not found in the physical sciences. Its popularity in the social sciences is sponsored by vested interests. There is always self-interest behind methodological madness.

That is because success requires heavy subsidies from special interests who benefit from an erroneous, misleading or deceptive economic logic. Why promote unrealistic abstractions, after all, if not to distract attention from reforms aimed at creating rules that oblige people actually to earn their income rather than simply extracting it from the rest of the economy?

Michael Hudson

Links and Notes:



{3} John H Williams, Postwar Monetary Plans and Other Essays, third edition (New York: 1947), from page 134.

{4} I have surveyed the methodology in "The Use and Abuse of Mathematical Economics", Journal of Economic Studies 27 (2000):292-315. I earlier criticized its application to international economic theorizing in Trade, Development and Foreign Debt (1992; new edition, 2009), especially chapter 11.

{5} Paul Samuelson "The Gains from International Trade", Canadian Journal of Economics and Political Science, Volume 5 (1939), page 205.

{6} William Vickery, Microeconomics (New York: 1964), page 5.

Michael's criticism is one that will strike a methodological note with many economists who feel that the discipline has moved too far into the realm of irrelevancy as economists look to formulate sound theorems based on "mathematical rigor" instead of theories based on basic social observations of human nature.

I believe that behavioral finance was a response to addressing many gaps that we readily observe in economic theory. Having completed a Master's in Economics at McGill University, I passed those mathematical courses, but I was always attracted to questions of economic methodology. My courses in philosophy taught me to question everything, including economic theorems.

Economics is an evolving field. As Isaiah Berlin would say, there is inherent beauty in diversity. Let there be mathematical modeling but let there also be more open debates on what is really going on in the economy.

My practical experience in the investment world taught me to be weary of quantitative models that claim to measure all risks. This is pure nonsense. Just a few years ago, everyone was claiming we "tamed risk once and for all", and then "BOOM!", 2008 humbled the sharpest minds on Wall Street.

The economists who were tracking the bigger macro trends - including the net issuance of CDOs and other securitized products and the trillions flowing to hedge funds and private equity funds - knew that the global financial system was heading for a hell of a collision.

Now, where is my copy of When Genius Failed? I just love that book.


Those of you who want to read more on this subject, should read this testimony from David Colander which was submitted to Congress in early September: The Failure of Economists to Account for Complexity. This is an excellent summary, well worth reading.

Saturday, December 19, 2009

The Real Copenhagen Fraud?

Johann Hari reports in the Independent on the truths Copenhagen ignored (hat tip Tom Naylor):

So that's it. The world's worst polluters – the people who are drastically altering the climate – gathered here in Copenhagen to announce they were going to carry on cooking, in defiance of all the scientific warnings.

They didn't seal the deal; they sealed the coffin for the world's low-lying islands, its glaciers, its North Pole, and millions of lives.

Those of us who watched this conference with open eyes aren't surprised. Every day, practical, intelligent solutions that would cut our emissions of warming gases have been offered by scientists, developing countries and protesters – and they have been systematically vetoed by the governments of North America and Europe.

It's worth recounting a few of the ideas that were summarily dismissed – because when the world finally resolves to find a real solution, we will have to revive them.

Discarded Idea One: The International Environmental Court. Any cuts that leaders claim they would like as a result of Copenhagen will be purely voluntary. If a government decides not to follow them, nothing will happen, except a mild blush, and disastrous warming. Canada signed up to cut its emissions at Kyoto, and then increased them by 26 per cent – and there were no consequences. Copenhagen could unleash a hundred Canadas.

The brave, articulate Bolivian delegates – who have seen their glaciers melt at a terrifying pace – objected. They said if countries are serious about reducing emissions, their cuts need to be policed by an International Environmental Court that has the power to punish people. This is hardly impractical. When our leaders and their corporate lobbies really care about an issue – say, on trade – they pool their sovereignty this way in a second. The World Trade Organisation fines and sanctions nations severely if (say) they don't follow strict copyright laws. Is a safe climate less important than a trademark?

Discarded Idea Two: Leave the fossil fuels in the ground. At meetings here, an extraordinary piece of hypocrisy has been pointed out by the new international chair of Friends of the Earth, Nnimmo Bassey, and the environmental writer George Monbiot. The governments of the world say they want drastically to cut their use of fossil fuels, yet at the same time they are enthusiastically digging up any fossil fuels they can find, and hunting for more. They are holding a fire extinguisher in one hand and a flame-thrower in the other.

Only one of these instincts can prevail. A study published earlier this year in the journal Nature showed that we can use only – at an absolute maximum – 60 per cent of all the oil, coal and gas we have already discovered if we are going to stay the right side of catastrophic runaway warming. So the first step in any rational climate deal would be an immediate moratorium on searching for more fossil fuels, and fair plans for how to decide which of the existing stock we will leave unused. As Bassey put it: "Keep the coal in the hole. Keep the oil in the soil. Keep the tar sand in the land." This option wasn't even discussed by our leaders.

Discarded Idea Three: Climate debt. The rich world has been responsible for 70 per cent of the warming gases in the atmosphere – yet 70 per cent of the effects are being felt in the developing world. Holland can build vast dykes to prevent its land flooding; Bangladesh can only drown. There is a cruel inverse relationship between cause and effect: the polluter doesn't pay.

So we have racked up a climate debt. We broke it; they paid. At this summit, for the first time, the poor countries rose in disgust. Their chief negotiator pointed out that the compensation offered "won't even pay for the coffins". The cliché that environmentalism is a rich person's ideology just gasped its final CO2-rich breath. As Naomi Klein put it: "At this summit, the pole of environmentalism has moved south."

When we are dividing up who has the right to emit the few remaining warming gases that the atmosphere can absorb, we need to realise that we are badly overdrawn. We have used up our share of warming gases, and then some. Yet the US and EU have dismissed the idea of climate debt out of hand. How can we get a lasting deal that every country agrees to if we ignore this basic principle of justice? Why should the poorest restrain themselves when the rich refuse to?

A deal based on these real ideas would actually cool the atmosphere. The alternatives championed at Copenhagen by the rich world – carbon offsetting, carbon trading, carbon capture – won't. They are a global placebo. The critics who say the real solutions are "unrealistic" don't seem to realise that their alternative is more implausible still: civilisation continuing merrily on a planet whose natural processes are rapidly breaking down.

Throughout the negotiations here, the world's low-lying island states have clung to the real ideas as a life raft, because they are the only way to save their countries from a swelling sea. It has been extraordinary to watch their representatives – quiet, sombre people with sad eyes – as they were forced to plead for their own existence. They tried persuasion and hard science and lyrical hymns of love for their lands, and all were ignored.

These discarded ideas – and dozens more like them – show once again that man-made global warming can be stopped. The intellectual blueprints exist just as surely as the technological blueprints. There would be sacrifices, yes – but they are considerably less than the sacrifices made by our grandparents in their greatest fight.

We will have to pay higher taxes and fly less to make the leap to a renewably powered world – but we will still be able to live an abundant life where we are warm and free and well fed. The only real losers will be the fossil fuel corporations and the petro-dictatorships.

But our politicians have not chosen this sane path. No: they have chosen inertia and low taxes and oil money today over survival tomorrow. The true face of our current system – and of Copenhagen – can be seen in the life-saving ideas it has so casually tossed into the bin.

You can watch Johann explaining some of the appalling loopholes being smuggled into the Copenhagen treaty below. Also, listen carefully to this CBC interview with James Hansen. He's widely regarded as the most influential climate scientist in the world and rightly dismisses cap & trade as pure "gimmickry".

It's a shame but it looks like Copenhagen was another climatic bust, just like Kyoto and Rio were. Next up, the global pension bust.


The National Post carried an article from Agence France Press, World leaders hammered over climate accord. Another excellent article from the Independent: Joss Garman: Copenhagen - Historic failure that will live in infamy.

Thursday, December 17, 2009

The Pension Debate?

Terence Corcoran of the National Post reports on the pension debate:
In Whitehorse today, Canada’s finance ministers meet to discuss the future of Canada’s pension system. No agreements are expected on how to enhance Canadians’ retirement savings. A pension summit is expected to take place later this year.

Today, FP Comment launches the first in a series on The Pension Debate. Is Canada’s pension system a shambles, as some argue? Are Canadians ill prepared to meet their financial futures post-retirement? Is the private defined-benefit system permanently impaired? Are mutual funds and other savings vehicles, including RRSPs, up to the job of protecting Canadians?

Do we need a new, government-backed secondary pension regime to accompany the Canadian Pension Plan and associated government retirement relief?

The Canadian pension management industry, in today’s first commentary, argues against new government intervention and in favour of reforms to enhance the role of the private sector. Our second commentary, from the C.D. Howe Institute, raises another volatile issue: the high cost of federal pension plans for government employees.

Tomorrow: How bad is our pension system?