Monday, November 30, 2009

Pension Tension on the Rise?

Colin Barr, senior writer at CNN Money reports that Pension tension is on the rise:
Retirement plans are on the mend, but the healing process is going to be long and painful.

In addition to taking a big chunk out of individuals' 401(k)s, last fall's market meltdown left 92% of corporate pension plans underfunded at year's end, according to a study by investment consultant Wilshire Associates.

As bad as that sounds, it pales in comparison to the shortfalls in public pension plans. At the end of 2006, public pension plans were already underfunded by $361 billion, according to the Pew Charitable Trusts. That was before the stock market collapse, soaring unemployment rates and tumbling tax revenues dealt municipal finances another blow.

The federal insurer of corporate pensions, the Pension Benefit Guaranty Corp., reported this month that it was $22 billion in the red in the most recent fiscal year. The PBGC takes over pensions when they are underfunded or when their sponsors go into bankruptcy, and makes up some of the payments due.

While the bounce in the stock market this year has helped the situation, observers say more pain is ahead.

Strapped municipalities will face pressure to cut back on promised benefits. Hard-hit companies will be forced to choose whether to invest in their businesses or to beef up their pension plans.

"We're going to face increasing stresses in the pension world over the next three to five years," said Leo Kolivakis, a pension industry consultant who writes the Pension Pulse blog. "People are hoping and praying the stock market will bail them out, but they're going to be disappointed."

There are several forces that account for the current pressure on pensions.

One problem was that companies didn't contribute enough to their pension plans. The reason: They were counting on high returns to pick up the slack, a scenario that didn't pan out in the stock market's lost decade.

Another was that many pension funds made bad investments, embracing so-called alternative investment classes, such as hedge funds and private equity, which have performed poorly in the market unwind.

At the same time, companies are now stuck having to pony up more. That's because of the weak economy, which has led the government to commit to low interest rates for the foreseeable future.

It's also because of the 2006 Pension Protection Act, which started taking effect last year. It includes a long overdue increase in the premiums charged by the PBGC and forces companies to be fully funded by 2015.

Congress moved late last year to ease some of the requirements and may yet stretch them out again. But in the meantime, numerous companies are facing higher funding requirements.

It all adds up to a continuing squeeze on pension funds' financial position.

"There are no good solutions in an economic downturn," said Alan Glickstein, senior retirement consultant at Watson Wyatt. "Everyone's got difficult choices right now."

The bills are starting to come due in state capitols. The West Virginia legislature recently passed a bill approving the sale of $225 million of bonds to help stressed local governments close their pension gaps. The city of Huntington in the state's southwestern corner had warned that a $125 million pension shortfall could force it into bankruptcy.

The situation is less dire for big companies. But they aren't out of the woods.

Among the companies with underfunded pension plans is oil giant Exxon, whose U.S. pension plan assets were worth $6.6 billion less than the plan's liabilities at the end of 2008. The firm has contributed $4.1 billion to its plans so far this year. And Exxon made $45 billion in profits last year and retains its triple-A credit rating, so there is more where that came from.

Less certain is the fate of workers and retirees tied to companies in troubled industries such as airlines, retail and manufacturing.

Goodyear, the Akron, Ohio, tiremaker that has cut thousands of jobs in the past year, said in its annual report that its U.S. pension funds were underfunded by $2.1 billion at the end of 2008. The company, which froze its U.S. salaried pension plan last December, warned that the underfunded status would "significantly increase our required contributions and pension expenses, which could impair our ability to achieve or sustain future profitability."

Goodyear says it expects to contribute at least $300 million to its pension plans this year, including $260 million it contributed in the first nine months.

OfficeMax, the Naperville, Ill., office retailer, last month contributed $100 million of its stock to a plan that was $435 million underfunded at the end of 2008.

Delta Airlines, the Atlanta-based operator of the Delta and Northwest airlines, said in its 2008 annual report it expects to spend $420 million this year on pension benefits. Its pension plans' liabilities exceeded their assets by $8.6 billion at the end of 2008.

While companies are surely hoping that the market rally that started in the spring will take the edge of some of those problems, pension watchers note that the past decade should have taught all of us a lesson about banking on big market gains.

"Companies are in the same place as individuals," said Steve Foresti, managing director at Wilshire Consulting. "Everyone needs to save more. The markets aren't going to bring these balances back." To top of page

I meant what I told Mr. Barr, if plan sponsors are hoping for stock market gains to lead them out of their pension woes, they'll be very disappointed. Why? Because the next 20 years will look nothing like the last 20 years. Given the historic low levels of bond yields, it's simply a pipe dream to think that asset appreciation will lead you out of this mess.

Pension deficits are a long-term structural problem that will require difficult choices ahead. I've been writing about global pension tension for over a year and unfortunately I have not seen governments take this issue seriously. Perhaps they're too scared to face the music (watch video below).

Sunday, November 29, 2009

Global Trade Indicating V-Recovery?

Jonathan Lynn of Thompson Reuters reports that global trade volumes rise sharply in third quarter:
World trade volumes grew sharply in the third quarter of this year, data from the Dutch CPB research institute showed on Friday, in a further sign that the global economy is pulling out of crisis.

CPB said trade volumes in the third quarter were 4.3 percent higher than in the second -- the second biggest quarter-on-quarter increase since it started tracking trade flows in 1991, and contrasting with a record 12.3 percent drop in the three months ended February.

The turning point appears to have been this summer, when trade in the three months ended July turned positive on a quarter-on-quarter basis for the first time since May last year, the institute said in its latest World Trade Monitor.

Looking at volatile monthly figures, trade in September grew by a record 5.3 percent after falling 1.5 percent in August, reflecting higher exports and imports in all regions, said the CPB Netherlands Bureau for Economic Policy and Analysis, whose data are used by the European Commission and World Bank.

But the long-term trend remains negative, with average volumes in the 12 months ended August showing a record 14.4 percent drop compared with the previous 12 months.

The World Trade Organisation has forecast that trade will contract by more than 10 percent this year -- the biggest drop since the Great Depression.
The CPB Netherlands Bureau for Economic Policy and Analysis publishes its World Trade Monitor every month. You can read it by clicking here.

Here are the key points:
  • Third quarter: world trade up by 4.3%, the first quarterly increase since the first quarter of 2008.
  • September: world trade up by 5.3% month on month, after a revised decline of 1.5% in August.
  • September: world trade still 14% below its peak of April 2008.

Yanick Desnoyers, Assistant Chief Economist at the National Bank of Canada wrote a Hot Chart, Global Trade Flows Surge in September that was used in the New$ to (Us)e blog:

A key concern in recent months has been that the run-up in markets and commodities was speculative in nature. Fortunately, it is accompanied by a strong resumption in global trade flows. According to data just released by the CPB Bureau of Economic Policy, global volume trade surged 5.3% in September, the biggest increase on record.

Interestingly, the resumption in global trade flows was widespread across regions covered by the CPB. In particular, imports from industrialized countries increased 4% in September and are up a whopping 20% on a quarterly annualized basis.

As today’s Hot Chart shows, this was the first quarterly rise in six quarters. This development is a confirmation that demand from industrialized countries is firming up. With such an improvement in global trade, we believe that global growth will be above trend in 2010, as also suggested by the unprecedented growth of the OECD leading indicator.


We must be wary of these YoY rates of change, considering the hugely depressed comps last year. For example, the Port of LA’s total October traffic was down 8.3% YoY, a big improvement from previous months’ 15-25% drops. Yet at 647,000 TEUs, it compares poorly with October 2007 (735k) or October 2006 (800k).

Also, the US is obviously an important part of the global trade flow. Since the Ports of LA and Long Beach combined handle 40% of the US container traffic, I fail to see where the global recovery comes from given that port traffic remains weak.

My take is that the massive fiscal and monetary stimulus is starting to be felt in the real economy and that in the next few months, economic indicators will likely surprise to the upside, especially in the US. Stay tuned but it's definitely looking like a stronger than anticipated recovery is on its way. Friday's employment report should confirm this.

Saturday, November 28, 2009

Bankers Want to Continue Protecting Us?

Diane Urquhart sent me this Toronto Star article by James Daw stating that bankers' group wants to continue to protect you:

Canada's bankers have woken up. Hearing the cries for a supplement to the Canada Pension Plan or other larger-scale plan, they decided to use some gang-style protection tactics to guard and expand their turf.

Don't let the government suck money into a single, quasi-public, one-size-fits-all plan, their Canadian Bankers Association warns in a report released Friday. Let us continue to protect you.

"Requiring younger people to belong to a new contributory public retirement plan could have the effect of diverting income they need for other purposes such as near-term savings objectives and also may not result in actual increases in overall savings rates."

The report has several ideas for improving private-sector offerings – described in words familiar to careful readers of a 2008 paper by Toronto pension lawyer James Pierlot, A Pension in Every Pot: Better Pensions for More Canadians.

Governments should offer relief from taxes and rules, the banks argue.

Yet they make no mention of the drain on retirement income caused once banks and insurers receive our meagre savings.

Canada has the highest investment fund fees in the world, enough on average to bleed 40 per cent of future retirement income from the most diligent savers.

Most of these funds lag market and pension returns. There's also the occasional bad advice and outright larceny by employees of banks and associated securities dealers.

Yet the banks' solution for stretching dollars in retirement is to keep more of our money. They ask to be able to sell life annuities from their branches.

Jean-Pierre Laporte, another Toronto pension lawyer, called as early as 2006 for an idea the banks dismiss: letting employees and employers take advantage of the efficiencies and lower cost of the CPP.

So, naturally, he dismisses the bankers' suggestion that Canada's retirement savings system is working – and would work better if only the tax incentives were more attractive.

"For anyone to argue our system works is ridiculous," Laporte said after reading the report.

"It only works for employees of government and large enterprises. They don't really tell us why (allowing Canadians to contribute to a large-scale pension like the CPP) would be a bad thing. They are saying the current system works – for us – so don't fix it."

Pierlot agrees with the bankers that Canadians should have more choice of ways to save, including private-sector pensions that could serve multiple workplaces, the self-employed, members of associations and individuals. He proposed this a year ago.

Yet he asks: "If choice is a good thing, why not have the reforms the paper proposes as well as new government options?"

The bankers have put their weight behind other proposals included in Pierlot's paper for the C.D. Howe Institute, which is a good thing.

We should let everyone have as much tax-deferred retirement savings room as government employees, plus top-up room after breaks in employment or fluctuations in income. We should harmonize pension legislation across the country.

But Pierlot chides the bankers for treating statistics on retirement savings as though members of public- and private-sector pension plans are all the same. "The difference between the two sectors matters because one has a problem, the other doesn't," he says.

The bankers suggest things would be so much better for workers who rarely have a pension or save much before age 35 if they had more tax-assisted savings room later in life.

More saving room later in life would help, but it's hard to catch up even if you have the room. So starting early and having investment returns compound over many years is better, if you can do it.

I agree with Mr. Laporte, to claim that our pension system is working is simply ridiculous. The bankers, like the insurers, will vigorously defend the private sector solution for our ailing pension system but the reality is that they're charging outrageous fees and leave far too many people scrambling for retirement security. In short, the bankers will defend their profits but they're not delivering the goods at a reasonable cost.


Ken Georgetti, president of the Canadian Labout Congress, writes that improving CPP is answer to pension woes:

Re:Bankers' group wants to continue
to protect you, Nov. 28

The Canadian Bankers Association, as you report, thinks there's nothing wrong with our retirement security system that their products can't fix. Their suggestion to meet growing poverty among seniors and the severe holes in our patchwork system of pensions is, not surprisingly, a better tax regime to encourage more investment in what they have to sell.

Even some bankers, however, acknowledge that our decades-long experiment with RRSPs has failed. Don Drummond, chief economist of TD Bank, has called RRSPs into question and suggested that we need stronger public pensions, such as higher benefits through the Canada Pension Plan.

Despite what the bankers association says, the wheels have fallen off. The value of RRSPs has tanked and Canadian financial firms charge some of the highest administrative fees in the world, contributing to the industry's hefty profits.

I say that the CPP is a dependable vehicle – a model of efficiency, portability and stability covering 93 per cent of workers in Canada. Improving CPP benefits, even doubling them over time, is achievable and affordable. A growing number of economists and actuaries are coming to the same conclusion, which clearly frightens the Canadian Bankers Association.

One caveat: we need to improve transparency and accountability at the CPPIB.

Friday, November 27, 2009

Putin for Pensions?

Greg Bryanski of Thomson Reuters reports that Russia's Putin sees economy boost from higher pensions:
Russian pensioners who will have 46 percent more money in 2010 than this year will provide a much needed boost for the flagging economy as they spend, Prime Minister Vladimir Putin said on Wednesday.

'Our decision to increase pensions may contradict (the goal of maintaining macro stability). But at the same time it is a stimulus. It is consumption,' Putin told a pensions conference in Moscow.

Putin said the pensioners, who spend 80 percent of their meagre income on consumption, shun expensive imported goods and tend to buy domestically produced ones.

Russia, hit harder by the economic crisis than most other major emerging economy, is very slow to recover due to the very weak domestic demand and Putin has vowed to continue stimulus policies, helping the demand recover.

Russia is raising pensions by 35 percent in 2009 and plans to raise them further in 2010, envisaging to spend a staggering 10 percent of GDP on pensions and other social benefits.

As a result of the increase, the average pension will rise to 8,000 roubles ($277.4), breaching the minimum subsistence level and achieving a replacement ratio of 39.7 percent on the average post-crisis salary.

The pensions increase will also bring an eight percentage points hike in social security taxes to 34 percent of income from 2011, a move generally opposed by businessmen.

So what gives? Did the Christmas spirit strike Vladi early this year? Or could it be that polls are showing support for Putin and Medvedev is falling:

Prime Minister Vladimir Putin's approval rating has fallen to an eight-month low, a poll said on Wednesday, as faith in Russia's leaders is tested by an economic crisis that has put more than one million people out of work.

Despite a sharp deterioration in the economy, Putin and ally President Dmitry Medvedev have enjoyed high ratings since they took up their posts last year. But polls have shown their public approval fall steadily in recent months.

Public trust in the work of Putin fell from a peak of 72 percent in mid-October to 65 percent on November 22, the lowest point since March, according to weekly poll figures posted on the site of the Public Opinion Foundation on Wednesday.

Medvedev's rating stood at 54 percent, down from 62 percent in October.

"This is extremely serious for the government," Moscow Carnegie Centre analyst Nikolai Petrov said. "In the absence of any stable political institutions, Putin's popularity is the foundation of the country's political stability."

He said the fall was clearly caused by the economic crisis, and government decisions to raise pensions and scrap a controversial transport tax were efforts to stem the fall.

Russia remains mired in a deep economic crisis, with GDP contracting 8.9 pct in the third quarter from a year earlier. Unemployment has climbed by more than a third, from 4.1 million in May last year to 5.8 million in October.

Trust in the prime minister's office fell from 80 percent in August to 73 percent in November, according to rival pollster VtSIOM. A third poll from the Levada centre registered a fall in trust in Putin from 66 percent in August to 60 in November.

"Putin and Medvedev's ratings are not directly dependent on what they do and say, they reflect the general situation in the country," Levada Centre analyst Denis Volkov said. "We have seen a steady fall, but no collapse."

Public trust in Medvedev fell from 58 percent in August to 51 percent in October, according to the Levada Centre. The

Kremlin-aligned analyst Sergei Markov warned against reading too much into the poll ratings, saying ratings always fell as Russia's long, grey winter.

"They'll get better again in May when the sun comes out," he said.

Regardless of the reasons, I think Putin is onto something. Now, if only we can figure out a way to redistribute income from Wall Street crooks back into the pensions they keep plundering.

Thursday, November 26, 2009

Is Dubai's Sovereign Risk Overblown?

Laura Cochrane and Tal Barak Harif of Bloomberg report that Dubai Debt Delay Rattles Confidence in Gulf Borrowers:
Dubai shook investor confidence across the Persian Gulf after its proposal to delay debt payments risked triggering the biggest sovereign default since Argentina in 2001.

The cost of protecting government notes from Abu Dhabi to Bahrain rose, extending the steepest increase since February as Dubai World, with $59 billion of liabilities, sought a “standstill” agreement from creditors. Its debt includes $3.52 billion of bonds due Dec. 14 from property unit Nakheel PJSC. Dubai credit-default swaps climbed 90 basis points to 530 after yesterday increasing the most since they began trading in January, CMA Datavision prices showed.

“There is nothing investors dislike more than this kind of event,” said Norval Loftus, the head of convertible bonds and Islamic debt at Matrix Group Ltd. in London, which manages $2.5 billion of assets including Dubai credits. “The worst-case scenario will, of course, be involuntary restructuring on the Nakheel security that brings into question the entire nature of the sovereign support for various borrowers in the region.”

Dubai World’s assets range from stakes in Las Vegas casino company MGM Mirage to London-traded bank Standard Chartered Plc and luxury retailer Barneys New York through asset-management firm Istithmar PJSC. The Dubai government’s attempt to reschedule debt triggered declines in stocks worldwide that had been rebounding from the worst financial crisis since the Great Depression.

Many investors didn't foresee the scale of Dubai's debt problems. I spoke to a consultant today who told me that lawyers and accountants he knew working in Dubai kept telling him how Dubai's investment authorities are aggressively financing their purchases of global assets.

So will Dubai's debt problems plunge global markets to new lows? I strongly doubt it. Jan Randolph, head of the sovereign risk group at IHS Global Insight, talked with Bloomberg's Mark Barton about Dubai's proposal to delay debt payments and the role neighboring emirate Abu Dhabi may play in easing the crisis.

Mr. Randolph thinks Dubai's sovereign risk is overblown and I agree. He says this is essentially a liquidity problem and the debt represents 20% of GDP. He mentioned that Abu Dhabi which is the real cash cow, can easily bail out Dubai. Abu Dhabi's sovereign wealth fund is the world's largest, with over $600 billion in assets. It can easily support Dubai's debt problems.

What does all this mean for global investors in the next few days? Nothing much except that you'll have another opportunity to buy a dip, which is what you'll do if you're intelligent (that's what Goldman and JP Morgan will be doing). Nothing has fundamentally changed. The Fed is staying on the sidelines for the foreseeable future and they'll let this bubble blow. The global liquidity rally has legs to run, so don't get too flustered by Dubai's debt woes.

Another interesting trend is what's going on in China. Kevin Hamlin of Bloomberg reports that China Overcapacity Wreaks Global Harm, EU Group Says:
China’s excess industrial capacity is “wreaking far-reaching damage on the global economy,” stoking trade tensions and raising the risk of bad loans, the European Union Chamber of Commerce in China said.

A 4 trillion yuan ($586 billion) stimulus package is worsening overcapacity, especially in the steel, aluminum, cement, chemical, refining and wind-power equipment industries, according to a study by the chamber and Roland Berger Strategy Consultants, released in Beijing today.

The world’s third-biggest economy has rebounded this year on stimulus spending and a $1.3 trillion credit boom. China is adding capacity when global demand is yet to recover from the financial crisis, increasing the risk of trade frictions undermining commerce and making the threat of non-performing loans within the nation “ever larger,” the EU Chamber said.

“The Chinese stimulus package has poured credit into increasingly questionable projects,” the business group said, without identifying specific ventures. “The global impact already can be felt in the form of growing trade tensions.”

U.S. President Barack Obama and Chinese President Hu Jintao pledged this month to work to ease frictions, exacerbated by U.S. duties on Chinese tires.

The chamber recommended 30 measures to cut overcapacity, including letting an undervalued yuan gradually appreciate, reducing a “subsidy” for Chinese manufacturers.

Energy Prices

It also proposed lowering energy-price subsidies, raising interest rates to reduce easy credit, increasing dividend payments by state-owned enterprises, and spending more on health care and social security to encourage consumption and cut precautionary savings.

No comment was immediately available today from China’s commerce ministry.

In September, China’s State Council approved plans to curb expansion in industries including steel, cement, glass, coke, wind turbines and shipbuilding. The government has also introduced measures to limit land supply to sectors with excess capacity. So far, the government’s efforts have been ineffective, the chamber said.

China’s excess capacity is an “international concern” as goods that can’t be sold locally may be sent to markets that shrank because of the global slump, European Union Trade Commissioner Catherine Ashton said in Beijing Sept. 9. Ashton has since been named the EU’s top diplomat.

‘Unfounded’ Criticism

Yu Yongding, a former adviser to the Chinese central bank, said yesterday in Melbourne that that the “worrying” long-term effects of China’s expansionary policies include overcapacity, bad loans, and inefficient investment.

Not everyone agrees with the EU Chamber’s assessment. Isaac Meng, a senior economist at BNP Paribas SA in Beijing, said industries including steel and cement are not big exporters and claims of damage to the global economy are “unfounded.”

“In sectors where China is a massive exporter, like electronics, there’s no overcapacity because when exports collapse factories just close,” he added.

Increasing trade tensions between China and the U.S. are the result of high unemployment in the U.S., which is creating “political pressure to reduce China’s exports,” Meng said.

China as ‘Victim’

China’s own economy is the main “victim” of excess capacity, the chamber said. Lower profits mean companies lack cash to invest in research and development and develop more valued-added goods, it said. Businesses are also forced to cut costs, contributing to slower wage growth and less consumption, the report added.

“This is a major obstacle on the government’s path to become both an innovative and sustainable economy,” the report said.

China’s lending surge this year focused mainly on expanding production at state-owned enterprises, the report said. This led growth in fixed-asset investment by manufacturing companies to jump to 50 percent by mid-year from 25 percent in January and February, the chamber said.

Companies in industries with overcapacity will struggle to repay credit, increasing the risk of a repeat of the 1990s surge in non-performing loans, the chamber said.

China’s five largest banks have submitted plans to regulators for raising money after unprecedented lending eroded their capital, according to four people with knowledge of the matter.

It’s “particularly troubling” that more than 140 billion yuan was invested in the steel industry in the first half of this year and that 58 million tons of capacity are under construction when global demand may decline 14.9 percent in 2009, the report said. The chamber also warned of “a looming deluge” of extra cement capacity in the nation.

On the one hand you have the Fed flushing the financial system with liquidity and on the other you have massive Chinese stimulus leading to huge excess capacity in some sectors. Will China export inflation or will it once again export another wave of goods deflation? It sure looks like the latter.

Finally all this talk of sovereign risk, Dubai debt, China overcapacity, and global financial nervousness is really trivial. For a second year in a row, I watched CNN's Heroes. If you want to know the real meaning of life, stick your nose out your Bloomberg screen and read up on these remarkable individuals who through their selfless actions make a real difference in people's lives.

California Rumblings?

Jim Christie of Reuters reports that Los Angeles' budget gaps may force dramatic change:
Los Angeles must take dramatic steps in coming months to bring its budget back into balance, including measures to slim the size of its government and reduce how much it spends on pensions for retired employees, the city's top budget official said on Wednesday.

Los Angeles, California's biggest city, is seeing a steep drop in revenues fueled by the state's 12.5 percent unemployment rate, a slump in consumer spending, an uncertain housing market and a weakening commercial real estate sector.

Fitch Ratings has grown so concerned about Los Angeles' budget woes that on Tuesday it downgraded the city's general obligation debt to AA-minus from AA.

Fitch said it expects the city's economic decline to impede financial recovery. Among problems it cited were high unemployment, sales tax weakness, assessed value losses, high home foreclosure and negative amortization mortgage exposure.

Miguel Santana, the city's administrative officer, said he was not surprised by the downgrade. He is intimately aware of how the city's finances are faring, and they're in dire shape, he told Reuters in a telephone interview after briefing the city council on options for balancing the city's books.

Officials must close a nearly $100 million gap in the city's current-year budget, and are likely to use reserve funds to do so, Santana said.

"Next year we're expecting a $400 million deficit," he said.

"We really need to prioritize our programs," he added, noting that tapping reserve funds next year would be imprudent.

Instead, difficult choices about the size of Los Angeles government should be made. "Next year we'll have to find some real structural adjustments," Santana said.

Those adjustments may include layoffs and shifting some work done by the city to the private sector to shave costs.

They may also include a new pension benefit structure for city employees -- the so-called "two tier" system that many local officials around California are mulling.

The system would basically have new public employees hired after a certain date receive fewer pension benefits than current employees.

New public workers may also have to contribute more from their paychecks to their retirement accounts.

"We're looking at everything," Santana said.

Fitch in its statement underscored its concern about how much Los Angeles may be spending on pension benefits.

"As rising pension costs contribute significantly to the future financial needs, the city cites pension reform as necessary to achieve fiscal balance and has already begun discussions with some labor groups. However, Fitch views the ability to achieve savings in this expense as uncertain in both amount and timing, especially since any change to the police and fire retirement systems requires voter approval," the credit rating agency said.
What's going on in Los Angeles will soon be going on across the US and developed world. Don't think for a second that tough fiscal measures won't be taken to shore up public finances. And this will certainly mean curtailing pension benefits for new and existing public sector employees.

Elsewhere in California, Reuters reports that Calpers may dump Blackrock as an adviser:
Calpers, the biggest U.S. public pension fund, is considering dumping asset manager giant BlackRock Inc as one of its real estate investment advisers, a person familiar with the matter said.

The California Public Employees' Retirement System is also investigating why two outside pension advisors were managing its $6.8 billion hedge fund portfolio two years after their contracts had lapsed, the Los Angeles Times reported on Wednesday.

Calpers, which has suffered major losses on private equity and real estate during the credit crisis, recently informed BlackRock and other advisers that it was reviewing the relationships and would decide whether to continue or sever ties.

BlackRock, one of the world's largest money managers and a company that has thrived during the crisis, nonetheless steered Calpers into investing $500 million into Peter Cooper Village and Stuyvesant Town, a sprawling 11,000-apartment Manhattan apartment complex.

That investment, inked near the height of the real estate boom, is now widely considered worthless, the Wall Street Journal said on Wednesday, citing unidentified sources. The housing complex is owned by Tishman Speyer Props LLC and BlackRock.

BlackRock declined to comment on the Calpers review, citing a policy against discussing client activity. Calpers paid BlackRock $12.6 million in real estate advisory fees last year, the Journal said.

The real-estate review began several months ago and could be completed during a meeting next month. Real estate advisers are expected to learn the results of the review in January, said the person briefed on the situation, who was not authorized to speak publicly about it.

Calpers spokesman Brad Pacheco told the Journal the $200 billion pension fund would not "speculate on the future of our real-estate relationships until the review is complete."

Calpers officials in Sacramento, California, could not be reached for comment.

BlackRock shares were up 0.4 percent at $230 in early trading.

The pension fund voted last week to reduce its exposure to fixed-income investments managed by AllianceBernstein and PIMCO, a unit of Allianz . Still, the pension granted one-year contract extensions with the two firms.


In related news, Calpers placed an official who oversees its $5.8 billion of hedge fund stakes on leave, the Los Angeles Times said, citing people briefed on the matter.

The advisers have been working with the pension fund since 2003, but their contracts lapsed two years ago, the newspaper said. Calpers officials found these advisers were paid $36 million.

A Calpers' spokesman told the paper that it was investigating dealings with outside advisers, but declined to discuss the disciplinary action further.

"We recently discovered that certain Calpers controls and procedures were not followed in the last two years," Pacheco told the Times.
Certain Calpers controls and procedures were not followed? Damn, what a shocker! I have seen or heard about lax internal controls countless times. From front-running currencies in personal accounts to shady side dealings with investment managers. You name it and I've seen or heard about it.

I will repeat this again, these large public pension funds need a thorough performance, operational and fraud audit conducted once a year by independent experts and the results should be publicly posted on their websites. Let's put some teeth into the meaning of fiduciary duty or else we can expect one disaster after another.

Happy Thanksgiving to my US readers.

Tuesday, November 24, 2009

Will Pensions Ever Recover?

Karen Mazurkewich reports that according to a survey, plan sponsors worry about pensions:
The swell of negative pension news continues. RBC Dexia released a poll Monday revealing that the majority of Canadian plan sponsors are pessimistic about the future of their pension plans.

According to their survey, 89% of defined-benefit plan sponsors are concerned that the pension system is poorly positioned to deliver on its promises.

Just weeks before the Dec. 17-18 meeting in Whitehorse between the provincial finance ministers and Jim Flaherty, Minister of Finance, in which pension reform will be a major topic, the RBC Dexia results serves as yet another warning about the problems inherent within the system.

The biggest concern expressed by respondents is investment risk. With markets in a free fall last year, 41% of plan sponsors expressed fears over bad returns. Not surprisingly, their second-greatest fear is that plans will not generate sufficient returns to offset obligations.

Despite concerns over the pension system, the survey revealed some contradictions. Despite their overwhelming pessimism, 72% of respondents also rank Canada’s pension system as equal to, or better than, other systems globally, and 8% believed our system to be inferior to its global counterparts.

“There is recognition that it could be worse and (we) don’t want to throw out the baby with the bath water,” said Scott MacDonald, head of pensions, financial institutions and client service for RBC Dexia. But he also said the fact that 20% of respondents had no opinion on Canada and other approaches out there reveals “a community out there lacking context.”

The RBC Dexia poll comes on the heels of another plea last week by Keith Ambachtsheer, director of the Rotman International Centre for Pension Management. Using C.D. Howe Institute as his pulpit, Mr. Ambachtsheer argued that Canada’s supplemental pensions, such as the Canada Pension Plan, Quebec Pension Plan and Old Age Security, “are increasingly showing (their) age,” and need to be updated.

“Pension plan designs should target a post-work standard of living that is adequate, achievable, and affordable,” Mr. Ambachtsheer said.

Several provincial studies prove that almost half of middle and high-income workers in this country will not be able to maintain their desired standard of living in the next 10 years, he says.

In addition to arguing that all forms of retirement saving should receive equal tax, regulatory, and disclosure treatment across all sectors of the workforce, Mr. Ambachtsheer has called for national, regional or group-based supplemental pension plans for workers without an employment pension plan.

“So far, three proposals to increase pension coverage have gained currency in Canada over the course of the last year,” said Mr. Ambachtsheer. The first proposal has been made in various forms by Canada’s insurance and mutual-fund industries. The second involves an expanded Canada Pension Plan, while the third option is the creation of a new supplementary pension plan either at a regional or national level.

He hopes the new Federal-Provincial Working Group on Pension Reform will hammer out a supplementary pension fund solution so Canadians will receive better coverage upon retirement.

“This is not a pie-in-the-sky pension vision, but an achievable big idea whose time has come."

Mr. Ambachtsheer argued in his paper published by the C.D. Howe Institute that Australia and other European countries such as the Netherlands have solved their pension coverage problem by requiring all workers to become members of funded workplace pension plans.

In the UK, Reuters reports record pension hole for world's biggest firms:

The financial crisis saddled the world's 100 largest companies with a record 220 billion euro (199 billion pounds) pension shortfall at end-September, up from 20 billion at the end of 2007, a study released on Monday said.

The survey, compiled by consulting actuaries Lane Clark & Peacock LCP.L, found that the average pension deficit for companies in the FTSE Global 100 index increased by 1.6 billion euros during 2008.

The report highlighted Royal Dutch Shell, IBM and General Electric, which each saw deficit increases of more than 15 billion euros, contrasting with surpluses reported in 2007.

LCP said that asset price gains during 2009 stemming from recovering markets had not compensated for falling corporate bond yields which are used to measure pension liabilities in company accounts.

Not surprisingly, IFAonline reports that a quarter of occupational pension schemes in the UK lack a strategy to monitor and mitigate risk, according to The Pensions Regulator:

Despite nearly three quarters of schemes reporting they have a risk process in place, only two thirds of trustee boards are very confident they are properly guarded against specific risks.

Just two fifths of schemes (43%) have confidence in the controls relating to data transfer, though trust in internal management of fraud was higher with two thirds (66%) being very confident in the process.

Larger schemes were much more likely (91%) to have a risk strategy compared to only 59% of smaller schemes, the figures from the Pensions Regulator's fourth annual governance survey suggest.

Default occupational schemes remain popular, however, with nearly two thirds of members invested in such a fund, though this may reflect employee inertia rather than the fund being suitable for the majority of members' investment needs and attitude towards risk, says the regulator.

The regulator today launches a campaign to encouraging good governance and administration and better management of pension scheme risks.

Pensions Regulator chief executive Tony Hobman says: "Good governance underpins secure pensions.

"Scheme members entrust their pension savings into the hands of others to a total estimate of more than £1trn in assets, often for decades of their working lives.

"This campaign is designed to build on progress made in recent years, recognising that trustees perform a critical role in protecting and managing pensions, and are faced with challenges in this difficult economic context."

Key Retirement Solutions reports that pension fund analysis shows recovery:

The nation's pension funds could take a significant amount of time to recover from credit crunch-induced losses, Trustnet has suggested.

According to a report from the investment specialist, the schemes have yet to return to pre-crisis levels - although many have posted impressive gains recently.

A total of six funds have registered a 100 per cent-plus increase over the year to November 2009.

However, pensions suffered across-the-board losses from near- unprecedented stock market conditions with the credit crunch at its height during 2008. For example, the FTSE 100 stocks index dropped 35 per cent across the year and reached its lowest level for over a decade this March.

Speaking to Trustnet, Neil Veitch, manager of the SVM UK Opportunities fund, said: "As economies have stabilised and risk premiums reduced, it is earnings that will be the next driver of the market over the next six months.

"We are now looking for more sustainable growth or cyclical stories where there are internal or external drivers, preferably both, to bring these earnings through."

Diminished pension fund values could result in some retirees using options to boost their incomes, such as equity release plans.

Trustnet's UK pension database covers around 7,000 separate funds.

Finally, I end this post on a sobering note. Andy Davies of Fair investments reports that pension funds hit by recession:

More than a third of consumers believe their pension funds have been depleted by the recession, Aviva has revealed.

Aviva's research claims that the recession has also forced one in ten of its customers to look for additional ways to supplement their retirement income to ensure they can maintain the quality of life they have become accustomed to.

Meanwhile, as a result of the recession, 23 per cent of people said that in the past year they have had to cut their outgoings to enable them to save enough for their retirement.

Aviva's poll of more than 1,200 people approaching retirement also revealed that a quarter of people have concerns about how they will fund their retirement in the future.

Around one in three people are worried about how rising living costs will impact them in years to come, while 19 per cent of savers are concerned that their pension pot will not be worth as much as they had originally planned.

The most worrying figure, according to Aviva, is that five per cent of the respondents – the equivalent of more than three million Brits, admitted that they will rely on part-time work to fund their retirement.

Commenting, Brian Bussell, director of pensions at Aviva, claims these figures highlights how "important it is for people to start saving for retirement as early as they can".

"Understandably, the recession has forced people to think about their retirement income and many have realised that they may not have sufficient funds to live through their final years in the comfort they have grown accustomed to," he said.

Urging people to start saving for their retirement as early as possible, Mr Bussell added: "We would encourage people to make use of their full range of assets, including investments, state benefits, pensions and property, to make sure that they aren't effectively cheating themselves out of the lifestyle they could enjoy."

It's more than just about urging people to save more. The road to recovery for pensions will be a long and arduous one. Plan sponsors are right to worry because what goes up fast can come down even faster. And that means the global pension hole will get wider as we move along, leaving far too many people to fend for themselves at a time when they should be enjoying their retirement.

Monday, November 23, 2009

Can We Dodge the Fiscal Bullet?

My boss emailed me this afternoon telling me the former governor of the Bank of Canada, David Dodge, was in Montreal. He asked me whether I would like to go listen to his speech and I immediately jumped at the opportunity.

David Dodge is one of the smartest people in finance and listening to him speak was a real treat. If I were running a big global macro hedge fund, I'd hire him as a senior advisor. His knowledge of economics and global economic issues is deep and comprehensive.

Mr. Dodge was the guest speaker at CIRANO. His presentation was entitled "Emerging from the Crisis: the Fiscal and Monetary Policy Challenges Ahead".

He began by going over the origins of the crisis, paying close attention to global imbalances, financial market innovation and underpricing of risk.

He then discussed how central banks and governments dealt with the crisis through liquidity provisions and government bailouts. He emphasized that automatic fiscal stabilizers accounted for over 50% of the fiscal deficits and that it wrong to think that the bailouts were the only driving force behind mushrooming fiscal deficits.

Mr. Dodge then listed four factors driving the economic rebound (he did not call it a recovery but a rebound):

1) reversal of inventory cycle
2) huge fiscal stimulus
3) extraordinary low interest rates
4) house price stabilization

And he listed two factors driving the financial rebound:

1) pessimism of last winter was overshot
2) extraordinary liquidity provision by central banks

According to Mr. Dodge, the rebound has come one or two quarters earlier than predicted last winter because of the size and speed of coordinated monetary and fiscal policy. The global economic contraction in 2009 now seems likely to be only 1% 9versus 2% last winter). Growth in 2010 now likely to be 3% (versus 2% last winter). Inflation is well contained.

But Mr. Dodge warned that private demand is still weak, household balance sheets in OECD remain problematic, and unemployment still to peak in 2010.

As far as the global financial system, Mr. Dodge said catastrophe was averted in 2009 but a substantial "hangover" remains:
  • government ownership of financial institutions
  • huge government deficits and high debt
  • central banks expanded balance sheets
  • securitization very weak and bank credit tight
  • And rebuilding of the system still to come
On the last point, Mr. Dodge notes that banks starting to rebuild capital with steep yield curve, substantial investment banking profits and equity issues. Risk management models are being recalibrated and "derisking" process underway. But he noted that little progress yet on reform of financial instruments and markets.

In particular, he noted the following key issues for market regulators:
  • standardization of instruments
  • building of continuous markets
  • regulating credit default swaps
  • need to develop a sustainable private mortgage market
  • need to harmonize accounting standards
Mr. Dodge then got to the core of his presentation, the fiscal outlook, noting the following:
  • In 2007, Canadian federal and provincial bugets show a small surplus (1.3% of GDP)
  • Big reduction in net debt to to about 52% of GDP
  • Favorable terms of trade led to stronger nominal income growth (2002-2007)
But the global financial crisis dealt a severe blow to government revenues and automatically increased some expenditures. Moreover, governments undertook stimulus spending. The combined Canadian federal and provincial deficit in 2009-10 rose to about 6% of GDP, with slightly more than half of this increase due to automatic stabilizers. The comparable deficit in the US was over 10% of GDP.

In his fiscal outlook, Mr. Dodge went over several factors affecting future spending:
  • Assume temporary programs expire more or less as scheduled in 2011/12
  • Spending programs then largely driven by changing demographics
  • Health care costs continue to increase driven by aging (6%+)
  • Elderly benefit costs set to increase
To restore fiscal balance, Mr. Dodge says it would require discretionary fiscal action of roughly 3% of GDP (federal plus provincial). If all is done on spending side, program spending growth would have to be constrained to below 3% (nominal) and all temporary spending eliminated.
Restraint of this magnitude is very difficult and disruptive so some tax increases will be necessary.

To cut spending by 1 1/2% (1/2% of GDP per year), Mr. Dodge said you need to:
  • hold real capita spending to 1% growth p.a.
  • cut other real spending on other programs by 2% p.a.
To raise revenues by 1 1/2% of GDP by 2014-15, Mr. Dodge noted that you need to:
  • raise the harmonized sales tax (HST) by 2%
  • some form of carbon tax
  • raise user charges (eg. student fees)
Mr. Dodge ended with the implications for monetary policy:
  • Hold interest rates at zero 'til mid 2010 but reduce non-conventional initiatives
  • With credible fiscal plan, policy can remain accomodative through 2015, i.e. slow increase in policy rates to 2% (zero real) in 2010-2011 and hold below "neutral" through remainder of period to compensate for fiscal drag and continuing (small) output gap
And finally the implications for global policy coordination:
  • Canada is not an island
  • USA must reduce net absorption and Asia (especially China) increase net absorption (he also mentioned that other EM can start to run current account deficits)
  • Canada will have to adjust for global policy changes and unforeseen events
  • Adjustments can best be accomplished if baseline fiscal plan is credibly set to achieve balance (less than 1% deficit) by 2015 and monetary policy set to keep inflation at 2%
During the discussion period, Mr. Dodge said that risks of deflation and inflation remain. On the elusive issue of productivity, he repeated several times that Canada has not found a way to increase total factor productivity, something which he also recently lectured on to Laurentian University graduates.

Sunday, November 22, 2009

Illusion of Prosperity?

Peter Boockvar, equity strategist at Miller Tabak. recently appeared on Tech Ticker claiming "it's dangerous to short this market":

Despite a penchant for bearishness, Boockvar says the rally can continue as long as the Fed keeps rates at zero.

"When you cut rates to nothing you're encouraging people to take risk," Boockvar says. "As long as asset inflation is [the Fed's] goal, the market could go higher but there are obvious consequences," including inflation, as discussed here.

The Fed is trying to create "the illusion of prosperity" by fueling asset price appreciation, Boockvar says, staying true to his reputation as a deficit hawk. Even if the U.S. stock market keeps rallying, "non-dollar assets" like commodities and emerging markets will continue to outperform, he says.

Unlike the U.S., emerging markets are "not weighed down by enormous debt levels" and local consumers are "much better off" than their American counterparts, the strategist says, expressing a strong preference for China.

"If you want exposure to global growth, it's going to be outside of the U.S.," he says, recommending the following:

  • Follow the Money: Buy China-specific and Asian ETFs or mutual funds.
  • Go for Gold: A longtime gold bull, Boockvar says a correction could be coming because "the trade has gotten crowded" and Ben Bernnake's recent comments about the dollar could spur a reversal. But "buy on any sharp pullback," he recommends, suggesting gold is very likely to revisit its inflation-adjust high of $2300 "in the next few years."
  • Reject Domesticity: Avoid U.S. retailers, REITs and consumer-focused financials, Boockvar says, suggesting the U.S. economy and consumers will be under pressure for the foreseeable future. "If you want to invest in US, invest in companies with big exposures overseas," he says. "The growth is not going to be there in the U.S. "
As it turns out, last Tuesday I was in Toronto for a Global Insights conference where I got to listen to a senior economist for the IMF. She was excellent and she highlighted a few themes that that I outline below:
  • The IMF is acutely aware that excess liquidity is bidding up risk assets globally. They are particularly watching developments in China where a surge in lending has led to a boom
  • UK, and European banks have been slower than US banks to write down their impaired assets. The fragility of the global banking system will limit central banks from raising rates too fast and too high
  • The explosion of sovereign debt among developed countries will eventually lead to a crowding out effect, raising the cost of private capital.
After the presentation, I had lunch with my favorite pension fund manager. He's the type of guy who is always looking ahead, not back, when making investment decisions. Here is a little snippet of our conversation (not word for word):
Me: Only for you would I come up to this part of town.

Wise One: Good to see you, so what you've been up to?

Me: The usual, working, blogging and pissing off senior pension fund managers.

Wise one: So what brings you to Toronto?

Me: Was here for a Global Insights conference. Interesting presentations, especially the one from the IMF. She brought up the issue of excess liquidity. As you know, I've been calling for a major liquidity rally fueled by all this quantitative easing and propelled even higher by underperformance from institutions who totally missed the rally off March lows.

Me: I also think we are going to have some upside surprises in the US employment reports in the next few months with major upside revisions to the previous month's report.

Wise one: I would agree with you on both counts but we do see our twelve month leading indicators rolling over. This means the growth rates will taper off.

Me: Makes perfect sense because the stimulus will wear off so you would expect growth rates to come down in a year or so.

Wise one: So what did the IMF economist say?

Me: She spoke about excess liquidity in China, and around the world. She also spoke about bank impairments and how they will limit central banks' ability to raise rates too high, too quickly.

Wise one: Interesting, the two things I am worried about is some problems with China or emerging market debt and central banks pulling the trigger too quickly.

Me: I doubt they will raise rates too quickly but if employment reports start coming in strong, consensus expectations might shift abruptly. Everyone is expecting the Fed to stand pat for another year or so, but that could change.

Wise one: Indeed, it could.

Me: Look at the last year. The big money to be made was in beta trades like long stocks, long investment grade corporate bonds. On a risk-adjusted basis, the best trade in the last year was to have gone long investment grade corporate bonds. But big beta moves are over. In 2010, relative value trades will be the key to making money.

Wise one: I agree, real alpha is the key to making money in 2010. I think growth slowly comes off over the year. You'll first see it in global manufacturing. Looking closely at relative value trades.

Me: Let me throw a curve ball at you. What if we get another asset bubble where asset bubbles decouple from fundamentals? I asked that IMF economist whether they track hedge fund flows, sovereign wealth fund flows, private equity flows into the financial system and she told me yes, but that they're more concerned with banks.

Me: If you get another asset bubble, it could last a lot longer than what most people think. Like Keynes said, "markets can stay irrational longer than you can stay solvent".

Wise one: Yes, that is always a risk in these markets.

Me: I got to grab my train to Montreal. Thanks for meeting me and thanks for lunch. Before I leave, please read Graham Turner's book, No Way to Run an Economy. It is excellent and I will eventually review it on my blog.

Wise one: Will do, take care.
Let me end by stating that I am not in total agreement with Peter Boockvar. While I do believe it's dangerous to short this market, I see the US dollar rising in anticipation of better than expected jobs reports and you'll get back to a period where both the US stock market and the US dollar rise in unison. The liquidity rally can last a lot longer than we think, but risk assets can get whacked if inflation expectations abruptly shift or if central banks aggressively remove liquidity.

I also don't buy the argument that the US will lag the world. It's worth re-reading my post on Galton's fallacy and the myth of decoupling. As much as I like Chinese solar stocks, the US is still the engine of global economic growth. No US recovery means no sustainable global recovery.

Finally, there is no illusion of prosperity for US investment bankers raking in record bonuses. They seem to be totally oblivious to the plight of millions looking for work. As long as they get more for themselves, they couldn't care less about what is going on in the real economy.

Friday, November 20, 2009

Induced Bankruptcies Costing Taxpayers Billions?

Independent financial analyst Diane Urquhart sent me her latest research report, Induced Bankruptcies Cost Canadian Taxpayers Billions of Dollars Federal Government Not Stopping the Abuses.

Here are the key conclusions:

The credit default swap (CDS) invention of 1997 and the trend of private equity funds making leveraged acquisitions of large public corporations over the past decade are causing a proliferation of bankruptcies today in both the U.S. and Canada. The damages to the Canadian taxpayers and the economy from these induced corporate bankruptcies will be in the billions of dollars.

Canadian Federal bankruptcy laws are allowing corporations to walk away from their employee benefit obligations and to download onto Canadian taxpayers the additional costs for public social security programs and lost income taxes from the former employees whose employee benefits are being severely cut.

For example, I estimate that the Nortel liquidation will cost Federal and Provincial Governments at least $355 million in additional social security program expenditures and reduced income tax revenues, even though Nortel will have an estimated $6 billion plus of cash in its global bankruptcy estate.

The Canadian economy will experience the multiplier impact of an estimated $1,593 million of after-tax income and health care benefits lost by Nortel's close to 25,000 affected Canadian pensioners, survivor pensioners, active and deferred beneficiaries of pension plans, long term disabled and terminated employees.

The impacts are based on the present value of lost Nortel-provided annual income and health benefits, which have the following impacts on government: lost income taxes from all four Nortel former employee groups; additional Age Allowance and Medical Expense Tax Credits for pensioners, increased use of the Guaranteed Income Supplement and the Medical Expense Tax Credit for survivor pensioners, new use of Provincial means tested drug assistance programs for the long term disabled, and additional Federal Employment Insurance and Medical Expenses Tax Credit for the severed employees.

The recommended Bankruptcy and Insolvency Act (BIA) Amendment is to give preferred status for employee benefit claims over unsecured creditors. This is the best short-term and long-term solution to prevent corporations from walking away from their pension and long term disability plan deficits and unpaid severance, when there is money in the bankruptcy estate. This BIA Amendment ensures that Canadian taxpayers' interests are protected from the increased social security program costs and lost tax base that induced bankruptcies cause.

Key New Information in This Research Report

(1) Added estimates on the impact of Nortel's liquidation on the Survivor Pensioners and the Severed Employees.

(2) Added health benefit losses to the total loss of Nortel employee benefits and determined that the % loss in Nortel employee health and income benefits range from -35% to -55% in the best case of the estimated cash settlement ratio being $0.45 per $1.00 creditor claim; and, from -40% to -85% in the worst and likely case of the estimated cash settlement ratio being $0.15 per $1.00 creditor claim. The worse case assumes that the U.S. and U.K. government and U.S. junk bond creditors have improved their relative position by their hoarding of cash outside of Canada and by collecting their non-arms' length Debtor-in-Possession prior charge and other inter-company loans made to the Canada Estate.

(3) Added analysis on the % impact on the combined Nortel health and income benefits and the government social security programs as noted in Figure 2 above (click to enlarge image). The % loss on total income and health benefits from both Nortel and Government is in the range of -20% to -55% in the best case and -20% to 60% in the worst and likely case.

(4) Determined that Nortel's long term disabled employees have the severest damages amongst the four employee groups because: their future disability income has been deeply underfunded in a self-insured plan, Nortel has stopped making new cash contributions into the Health & Welfare Trust (H & WT) to pay for the current LTD income and so the capital in the H & WT is being depleted by current long term disability income being paid during the restructuring period; the long term disabled employees have heavy health care costs estimated at $12,000 annually whose reimbursement will be cut off at the time of Nortel's liquidation; the long term disabled are being threatened to lose their health benefits sooner if they attempted to shut down the H & WT to get their capital out now before it is depleted during the remainder of the restructuring period; the CPP Disability Income is a low $13,272 annually and the long term disabled cannot go back to work.

Diane's research has wider implications for employees and pensioners of other companies teetering on bankruptcy. If the explosion of CDS and leveraged buyouts is inducing a wave of bankruptcies, then why should taxpayers borne the cost? I say we tax the funds that are wreaking havoc on the real economy with their sophisticated financial "leveraging and hedging".

Thursday, November 19, 2009

Pension Reforms: Will Canada Lead the World?

Norma Greenaway of Canwest News Service reports that pension expert proposes fix for Canada's retirement saving shortfall:
A supplementary pension plan is needed to give middle-income Canadians without workplace pensions a better crack at securing a comfortable retirement, says Keith Ambachtsheer, one of the country's leading authorities on pensions.

Ambachtsheer, director of the Rotman International Centre for Pension Management at the University of Toronto, says governments must plug the hole in the system that leaves about four million Canadians on their own to build a better nest egg than the public pension system guarantees.

Ambachtsheer says the public system provides adequate income replacement for workers whose annual incomes are $30,000 or less.

But, he says, the combined income from the Canada Pension Plan, Old Age Security and the Guaranteed Income Supplement won't finance the type of retirement envisioned by many of those earning between $30,000 and $125,000 a year.

"There are a lot of people that aspire to have a long, comfortable, pleasant post-work life," Ambachtsheer said Thursday in an interview after the release of is latest pension report.

Many have lifestyles that require $60,000 or $70,000 a year to maintain after they stop working, and "$36,000 doesn't do it," Ambachtsheer said, referring to the current maximum value of benefits a retired couple can collect from CPP, OAS and GIS if it has no other income sources. The maximum benefit for a single person is about $19,000.

Ambachtsheer called on federal and provincial governments to rally around the idea of creating a supplementary national pension plan — separate from the CPP/QPP — that would allow the three of four workers in the private sector without workplace pensions to build a better retirement cushion.

Under Ambachtsheer's preferred formula, premiums would be set to provide the equivalent of 60 per cent of pre-retirement earnings when benefits from all pensions are combined. All employers and workers without a workplace pension plan would be automatically enrolled, but they could choose to opt out.

"(This) reform is about facilitating middle-income private sector workers so that they can have a decent, enjoyable post-work period of retirement, rather than ending up (at) a cliff — where as soon as their work income stops, their incomes goes in half."

Ambachtsheer's latest appeal comes as federal and provincial finance ministers prepare for a meeting in Whitehorse next month that some participants hope will result in the players agreeing to fashion a national approach to resolving what many see as a mushrooming retirement income crisis.

Ambachtsheer's proposal for a "Canada Supplementary Pension Plan" envisions joint federal-provincial involvement, but, he says, separate provincial or regional initiatives are feasible.

The governments of British Columbia and Alberta, which are ahead of the others on exploring provincial supplemental pension plans, say they would prefer a national approach, but they are prepared to go it alone if necessary.

Saskatchewan and Manitoba say that in the absence of a national plan, they would be interested in joining a possible western regional plan.

The Harper government is playing its cards close to its chest, saying it wants to wait until it sees the results of ongoing research into the adequacy of Canadians' retirement income, and how it compared to other countries. The research findings will be presented in Whitehorse.

Analysts say the recession has shone a light on long-standing gaps in a pension system. Even those with workplace pension plans are on edge, wondering whether their expected pensions will shrink or disappear if their employer goes bankrupt or gets into financial difficulties.

The Canadian Institute of Actuaries concluded in a study released last month "two-thirds of Canadians who plan to retire in 2030 may not be saving at levels required to meet household expenses in retirement."

Ambachtsheer prepared his latest pension report for the Benefactors Lecture series operated by the C.D. Howe Institute.

Mr. Ambachtsheer's report, Pension Reform: How Canada Can Lead the World, identifies the following problems with pension rules and regulations:

  • Private-sector workers cannot participate in the kind of large-scale, pooled arrangements that serve public-sector workers well. Such restrictions should be removed (see Pierlot 2008).
  • Workers cannot participate in pension plans that are not sponsored by their employers. This restriction should be removed to facilitate the creation of cost-effective collective pension arrangements (see Pierlot 2008).
  • Current legislation and regulations foster administrative complexity and restrict employers from exercising flexibility in sponsoring and contributing to a variety of pension arrangements. These complexities and restrictions should be removed (see Pierlot 2008).
  • Pension legislation and regulations should be harmonized across the country (see Van Riesen 2009).
  • A number of quantitative investment restrictions continue to hamper pension investments and should be removed (see Puri 2009).
  • Current tax rules restrict saving for retirement in a number of important ways, including through contribution ceilings, age-restrictions, and the definition of which types of income qualify for retirement-savings-related tax-deferral treatment. All these rules need to be reviewed and brought into the twenty-first century (see Banerjee and Robson 2008; Gunderson and Wilson 2009).
  • The treatment inequities between private-sector and public-sector workers should be dealt with (see Charron 2007).
  • Current RRIF rules force seniors to run their retirement savings down too quickly (see Robson 2008).
  • The 10 percent overfunding cap in DB plans hampers prudent risk-management practices (see Banerjee and Robson 2008).

He said the following principles should guide any plan to reform Canada's pension system:

  • Pension plan designs should target a post-work standard of living that is adequate, achievable, and affordable
  • All workers should have a simple, accessible, portable opportunity to participate in pension plans that have explicit post-work income-replacement targets
  • All forms of retirement saving should receive equal tax, regulatory, and disclosure treatment across all sectors of the Canadian workforce
  • Pension management and delivery structures should be expert, transparent, and cost effective.

On the issue of governance of large pension plans, Mr. Ambachtsheer writes:

Does the lower cost of large funds translate into a direct benefit on the investment side as well? The answer is yes. In fact, here the benefits are even better: on average, for every tenfold increase in the dollar value of fund assets, risk-adjusted net returns increase by twenty-seven basis points (that is, 0.27 percent); recall that, for every tenfold increase in dollar value, unit costs decrease by only seventeen basis points. Thus, on average, larger funds outperform smaller funds by more than just their lower unit cost advantage.

What explains these findings? Research suggests that a possible answer is the generally stronger governance capabilities of larger funds. A study by Ambachtsheer, Capelle, and Lum (2008) involving 88 pension funds finds a positive correlation between risk-adjusted net returns in the CEM database and the governance quality of those funds. Higher-quality governance is associated with the following behaviours:

  • a board of governors selection process that combines both representativeness and skills/experience criteria;
  • self-evaluation of board effectiveness;
  • clarity between the respective roles of the board and management;
  • the adoption of a high-performance culture with transparent and competitive compensation policies; and
  • insource and outsource decisions that are based purely on cost-effectiveness assessments.

In empirical analyses almost ten years apart, funds that scored well on these behaviours outperformed those that scored poorly by 1 to 2 percent per annum.

This is the biggest beef I've got with Mr. Ambachtsheer's "authoritative" report on pension reforms. He shamelessly cites his own firm's research and neglects to mention that his biggest clients are the very large pension plans he is commending for "good governance".

If you've been reading Pension Pulse, you know what is really going on at each and every large Canadian pension fund. Far from having good governance, most of these large funds are governed in an ad hoc fashion which provides the illusion of good governance. The claim that "Canada leads the world" on pension governance is an outright lie which ignores serious governance gaps that still remain in our pension system.

I can destroy each and every governance point Mr. Ambachtsheer raises above. First, the board of directors at these large public pension funds are made up of political hacks and industry types who in many cases don't have a clue about proper pension governance.

If it were up to me, I would add a few university professors from the finance, accounting and economics departments who have no industry ties whatsoever. I'd love to see pension fund managers try to pull fast ones over unbiased experts.

Second, self evaluation of board effectiveness is like Wall Street and Bay Street's self-regulation. It simply does not work and only acts like smoke and mirrors.

Third, there is no clarity between the respective roles of board and management. All too often the board tries to micromanage management instead of clearly defining their role and allowable risk parameters.

Fourth, the "adoption of a high-performance culture with transparent and competitive compensation policies" is typically based on bogus benchmarks which do not accurately reflect the risks of the underlying investments (particularly in private markets where benchmark abuse is rampant).

Fifth, decisions based purely on cost-effectiveness assessments is debatable. If pension funds are not disclosing who they do business with and what are the total costs of doing business, then we can never really know if they're delivering real added value to the plans they manage.

Sixth, and most important, everything should be disclosed at public pension funds. And I do mean everything. Benchmarks governing public and private markets, minutes from each board of directors' meeting, compensation for every senior officer, departures of senior managers, turnover rates, custodians, vendors, fees to external managers, internal operational costs, expense reports for senior managers and individual groups, etc. Public monies deserve full and public disclosure.

Finally, if you want to read an excellent article on pension reforms, I suggest you read Jean-Pierre Laporte's article in the June issue of Benefits and Pension Monitor, Supplemental CPP: An Idea Whose Time Has Come (on pages 38-39).

Canada can lead the world in pension reforms, but first let's get some basic disclosure and tighter oversight on investments and compensation policies. If you pay people to take stupid risks, don't be surprised when they deliver disastrous results.

Wednesday, November 18, 2009

New Normal For Retirement Benefits?

Bloomberg's Brian Parkin reports that German Government Forecasts Pension Growth Over Next 15 Years:
German Chancellor Angela Merkel’s government forecast state pensions will grow over the coming years, defying political and other critics who say that worker and company contributions will have to rise to finance growth.

Even with a freeze on pension increases this year and next, payments for retirees in the compulsory plan will grow by an average 1.6 percent per year to 2023, the Berlin-based Labor Ministry said today. Monthly contributions from gross pay will vary from 19.9 percent now to 20.6 percent in 2023, it said.

Labor Minister Franz Josef Jung hailed the pension program as a success, “proving itself, not least in the economic crisis.” The plan is “secure in spite of demographic change,” Jung said in an e-mailed statement.

Merkel’s coalition, which took office on Oct. 28, is under pressure to keep vows made to pensioners, who make up a quarter of the population and help prop up private consumption in an economy pegged to shrink the most since World War II this year. About 20 million pensioners are in receipt of 23 million pensions this year, according to the Labor Ministry.

Maintaining the pace of pension increments to 2023 will force the government to sell more bonds each year, according to critics including Alexander Bonde, a lawmaker with the opposition Green Party. About 80 billion euros ($120 billion) from Merkel’s 288 billion-euro budget will be spent on topping up pension coffers this year.

If pensions rise as Jung predicts, retirees paying average monthly premiums into the plan and with 45 years of salaried work behind them will be paid 1,533 euros per month, according to the ministry Web site. That compares with 1,224 euros now.

Demographic Change

The BDB banking group said that the government underestimates the pace of demographic change. The number of policy-holders of so-called Riester Plans, a private retirement plan backed by government subsidies, grew the slowest in five years in the third quarter, the BDB said.

“Unless we can boost motivation to buy capital-supported plans we’ll face big problems,” the federation said on its Web site. The group’s members including Deutsche Bank AG and Commerzbank AG sell private policies.

The working population of 20 to 64 year-olds accounts for 50 million out of Germany’s total population of 82 million at present, the Federal Statistics Office said today in a report. That will shrink “drastically” to about 40 million between 2020 and 2035 as the “baby boomers” of the 1960s retire, it said.

In Ireland, Stephen Collins of the Irish Times reports that Brian Cowen gave a strong hint that the old age pension will not be cut in the budget on December 9th:

Speaking at a pension fund awards ceremony at the RDS in Dublin, he outlined the measures introduced over the years to improve the living standards of pensioners and said it was not his objective “to undo all of that good work now”.

Mr Cowen told the audience at the European Pension Funds awards ceremony they should be mindful of the large number of people who didn’t have a lot of disposable income to participate in savings schemes or pension investments and relied on the State pension.

“It is my intention in dealing with the budgetary crisis to ensure that those people will not be adversely affected by the decisions we have to make,” he said.

Mr Cowen said budgets were not simply about balancing books – as important as that was, they were also about acknowledging what was important in society. “I am proud of the provision we made for pensioners during the good years. It is not my objective to undo all of that good work now.”

He said the financial crisis had caused a lot of worry for everyone, particularly elderly people. “Many pensioners around the country have been prudent in investing in pension funds in order to provide for themselves in their retirement years. I am saddened that those people who have been prudent and have been conscious of their obligations to themselves and their families in making such pensions provision, have had their investments greatly depleted as a result of the recent financial markets collapse.”

He added that with the collapse of the financial markets and share values, those people who looked to the banks as the safest return on their investment had seen their faith shattered. “Once regarded as blue-chip shares, they have now seen the value of shares in financial institutions virtually wiped out in a very short time.”

Jonathan Sibun of the Telegraph reports that pension deficits in Britain underestimated by £268bn:

Lloyds' stated pension obligations are €14.2bn shy of the real size of the deficit, while RBS's are €13.3bn behind, according to research from equity research house AlphaValue.

British Airways, which is pursuing a merger with Spanish airline Iberia, boasts the third highest shortfall at €10.5bn. The size of BA's pension deficit is being monitored by the airline's shareholders as Iberia has retained the right to walk away from the agreed merger pending the outcome of a triennial review at the UK carrier's pension fund.

Other companies boasting sizable differences between actual and stated pension obligations included Barclays, BT Group, GlaxoSmithKline and HSBC, according to the research.

BT revealed last week that its final-salary pension scheme deficit had more than doubled in the past six months from £4bn to £9.3bn. The change came as a result of movements in bond yields and inflation expectations, as well as changes to accounting regulations.

AlphaValue said many of the 430 companies monitored underestimated the true value of their pension deficits by assuming a low level of wage inflation and by adopting a high discount rate, a measure used to value pension funds' liabilities.

The research house said 31 companies had underestimated their deficits by 40pc or more, with UK firms among the worst offenders.

"More than one-third of 2008 pensions obligations – some €1,100bn – are recorded at UK companies, as this is where the largest companies operate with the largest defined-benefit commitments. The bulk of the "non-accounted-for" pension deficit is also with UK corporates, especially the banks, as they use rather high discount rates compared with non-UK peers," said Pierre-Yves Gauthier, a director at AlphaValue.

Companies are believed to be attempting to reduce stated pension deficits by scaling back projected wage rises and maximising the discount rate. Last year, average wage inflation fell from 3.7pc to 3.6pc, while discount rates grew from 5.38pc to 5.57pc. AlphaValue said the "spread" helped save European companies about €51bn in 2008.

Mr Gauthier said many companies had made efforts to correct valuations this year, but warned that volatile market conditions made it important to find consistent measurements, above all on discount rates.

Official figures from companies' 2008 accounts show pension deficits at the European companies growing 22pc last year to €280bn.

The AlphaValue research showed an additional €300bn of unrecognised deficits, the equivalent of 9pc of shareholders' equity.

In Australia, Richard Lowe of Global Pensions reports that AMP to increase its pension contribution to 12%:

Australian superannuation provider AMP will increase the pension contributions it pays for its employees to 12% from the mandatory 9% by 2014.

AMP chief executive Craig Dunn announced the decision during a business lunch in Melbourne, adding fuel to the ongoing debate around raising the current minimum employer contribution rate.

He said: "Australians, by and large, aren't natural savers. In fact, the average Chinese consumer saves at almost 30 times the rate that the average Australian does.

"It's been our mandatory savings in superannuation which have helped cushion the worst impacts of the global financial crisis. But of course, we should and can always do more."

The announcement follows separate comments by John Brogden, chief executive of the Investment and Financial Services Association (IFSA), and Chris Bowen, minister for financial services, superannuation and corporate law, that Australians would benefit from an increase in the mandatory contribution rate. (Global Pensions; November 2, 2009)

Treasury secretary Ken Henry claimed in a recent report that the current contribution level of 9% would provide "adequate" retirement income for most Australians, but Bowen argued "adequate" is not enough.

Dunn said: "We've decided, as a company, to increase the superannuation contribution we pay for our employees to 12 per cent by 2014. In fact, in our view, the issue of whether 9% is enough needs to be debated more broadly."

The comments were made during a Trans-Tasman Business Circle lunch, which Dunn used as an opportunity to explain the reasoning behind AMP's proposed merger with the Australian and New Zealand operations of AXA Asia Pacific.

AXA Asia Pacific rejected the A$11bn acquisition offer by AMP earlier this month, claiming the bid undervalued the company.
In the United States, Carla Fried of CBS Money Watch reports that the indicator to watch is the 401 (k) match:

A year ago, the 401(k) match became an expendable benefit for a big slice of Corporate America panicked about their revenue prospects in the throes of the financial crisis and recession. Watson Wyatt says about 25 percent of large firms it surveys reduced or suspended their match in 2009. An unofficial tab kept by the Pension Rights Center suggests that plenty of smaller firms followed suit.

401(k) Match Policy Signals Better Job Outlook

A new survey from Watson Wyatt suggests employers are slowly easing out of panic mode. Of firms that cut their match this year, 35 percent say they intend to reverse that decision in the next six months. That’s a sharp increase from June, when just 5 percent said they were going to reinstate their match in the near future.

Granted, 35 percent is not 95 percent, but the trend suggests that employers are now less concerned about layoffs and more focused on how to retain existing employees and attract new hires.

It’s Back — Sort of

Seventy percent of firms in the survey say they will reinstate the same matching formula that was in place before the cut/suspension. But 13 percent say they are coming back with a lower match, and 17 percent say they will now peg their match to annual profits. Seems we have ourselves an emerging New Normal for retirement benefits, too.

Market-Timing Employers Cost Employees Plenty

With Bill Bernstein’s strawberry and nausea retirement advice still fresh in my mind, it’s frustrating to realize that the firms that pulled the plug on their match in 2009 kept their employees from maxing out on the chance to buy low. It’s not just that employees lost their 2009 match; they also lost having that match participate in the 60 percent market rally since the March low. I’m guessing that’s not a strategy mentioned in the 401(k) educational material employers dutifully provide to plan participants.

In Charleston, West Virginia, two bills before the House and Senate would allow cities to enroll new hires in newer, less expensive pension programs. They also give cities 40 years to pay off their unfunded liability and any interest that has accumulated on that liability.

In New Jersey, Elise Young reports that New Jerseyans will fund pension benefits for a lobbyist earning $191,000 a year – just one of scores of non-government employees, including high-paid executives and their staffs, who are entitled to public retirement payouts.

In Russia, Sergei Nikolayev reports in the Moscow Times that Central Bank Averts $44M Pension Fund Heist:

The Central Bank has foiled an attempt to steal 1.25 billion rubles ($44 million) from the state’s Pension Fund using counterfeit documents, a scheme that bankers say couldn’t have been carried out by ordinary criminals.

The Pension Fund discovered the theft Monday when it received a notice from the Central Bank that 1.25 billion rubles had been transferred from its account, Marita Nagoga, a spokeswoman for the fund, said Tuesday. She said the Pension Fund had made no such request to the Central Bank, which holds the fund’s accounts.

The Pension Fund said the transactions were carried out after the Central Bank received two counterfeit payment orders, with fake signatures and stamps from the fund. The purported swindlers went to the bank’s Moscow Branch No. 5 on Friday evening, where they first managed to transfer 1.25 billion rubles, set aside for construction and planning work, to the Pension Fund’s account with the Central Bank. Then they made a second transfer, moving those funds to an account controlled by Spetstekhprom at Kuban bank, an Interior Ministry source said.

The two transfers were completed Friday, and on Saturday the criminals began transferring the funds to a variety of different banks, including some abroad. By Tuesday evening, the Central Bank had managed to block the transfers and return the money to the Pension Fund.

A secretary at Kuban, who only gave her first name, Irina, told Vedomosti that the bank’s managers could not speak to journalists because they had all been taken away for questioning after their office was searched.

Kuban has existed since 1989, but little is known about the lender, which doesn’t have a web site. According to the Interfax-100 bank ratings, Kuban has assets of 223 million rubles ($7.75 million) and capital of 42 million rubles, and it is not part of the state’s deposit insurance system.

Alexei Frenkel, a banker convicted last year for organizing the 2006 murder of Central Bank First Deputy Chairman Andrei Kozlov, listed Kuban among the banks that he said were unfairly denied access to the deposit insurance program because they were suspected of money laundering.

The bank was led by Marina Burova for several years, but her place was recently taken by Vladimir Zasorin, according to the industry portal.

A bank executive said it was possible that the lender was purchased before the attempted theft in order to carry out the heist. Vedomosti was not able to confirm with the Central Bank the changes in management or the possible change in ownership at Kuban. People who answered the bank’s telephones declined to identify the lender’s director.

If the Central Bank believed that a bank was being used to steal money, it could block the lender’s correspondent account, said Andrei Yegorov, first deputy chief of SB Bank. Then cash could only be withdrawn in person, but the criminals either decided not to do that, or the bank was not the end point for the theft, he said.

The Central Bank sees all ruble transactions within the country, and it takes several days for ruble payments to go abroad, which means the regulator has plenty of time to look into them, said a vice president at another bank.

The bankers said they were baffled, however, that the swindlers were able to bring counterfeit payment orders to the Central Bank.

All banks are Central Bank clients, and officials at several lenders explained how things work at the regulator’s offices. Outsiders aren’t even allowed into Central Bank branches, which require a special pass. The passes are typically given to two or three representatives for Central Bank clients who have legal authority to order transactions.

Even if a client gets a new representative, preparing the entry pass takes several days. The electronic system means that it’s easy to see who has entered branches and at what time, one of the bankers said. Additionally, there are video cameras monitoring the work of all Central Bank tellers.

A teller is not required to check the authenticity of a payment order, another banker said. They just look to make sure that the bank managers’ signatures are present and that the stamps match those on record at the bank. As a result, any representative who regularly visits the Central Bank could conceivably counterfeit and deliver faked documents.

Nagoga said all of the Pension Fund’s transactions were done electronically and that no one from the fund brought requests to the Central Bank on Friday evening. A well-informed banker said the Central Bank would not necessarily find anything suspicious about the order, since such payments are not uncommon, but that an unfamiliar representative would likely put a teller on guard.

“The Central Bank has created a commission, led by First Deputy Chairman Georgy Luntovsky, to carry out an internal investigation,” the Central Bank said.

Finally, George Frey of BusinessWeek reports that European Central Bank President Jean-Claude Trichet on Wednesday urged European insurers and pension funds to have sufficient capital on hand, stressing they are "systemically important" to the financial system:

Trichet, who has long encouraged the eurozone's commercial banks to build their capital reserves, noted the companies play an important role in ensuring stability due to their size, investments, interconnectedness and the economic function of insurance.

In remarks at the Euro Finance Week in Frankfurt, Trichet warned there are "reasons to be cautious about the durability of the recent recovery of insurers' profitability."

He said "the supportive environment for investment income is unlikely to continue once market conditions begin to normalize." He did not elaborate.

"Although there are few solvency concerns facing the industry, there is no room for complacency in this environment. Insurers will have to be mindful of having sufficient capital buffers in place.

"The default of an insurer could cause financial distress in these sectors."

He said euro zone insurers and pension funds had about euro6 trillion ($9 trillion) in investments at the end of June and that they held about euro435 billion of debt securities issued by euro area banks, representing about 10 percent of the total debt securities outstanding at those banks.

The eurozone counts 16 countries sharing the single currency. Some of its biggest insurers include Allianz SE and Munich Reinsurance AG in Germany and AXA SA of France.

Insurers and reinsurers, which sell backup coverage to insurance companies to spread risk in the event of catastrophe, are closely watched for their investment decisions and assessment of the economy because they generally invest large sums of premium capital.

"Most of the time, given the typically long-term investment horizons of insurance companies and pension funds, they are a source of stability for financial markets. However, due to the sheer size of their investment portfolios, reallocations of funds or the unwinding of positions by these institutions have the potential to move markets. In extreme cases, that could put at risk financial stability by triggering large swings in asset prices," Trichet said.

I have long argued that insurers and pension funds need to be monitored by regulatory agencies that respond to systemic risks. Unfortunately, the New Normal for retirement benefits looks a lot like the old normal based on chicanery and deceit. When will we ever learn?