Will New Regulations Sink Pensions?

Before getting into my new topic, want to publicly congratulate Jim Keohane, CIO at the Hospital of Ontario Pension Plan (HOOPP). Jim will become HOOPP’s new President & CEO at the beginning of 2012, following current CEO John Crocker’s planned retirement, which takes place at the end of December.

Had a chance to meet up with Jim and Andy Moysiuk who runs HOOPP Capital Partners earlier this summer and wrote about it in a comment discussing whether pensions should be in the seeding game. I was extremely impressed with the people, culture, organization, their knowledge of pensions and markets, and how they run a no nonsense tight shop that focuses on teamwork and results. Don't agree with everything HOOPP does but its long-term track record speaks for itself; HOOPP is one of the best defined-benefit pension plans in the world, escaping the savage losses that rocked pensions in 2008, and consistently delivering superior risk-adjusted returns. With Jim at their helm, they will continue delivering stellar results.

Unfortunately most pension plans are not managed like HOOPP and they will suffer huge losses once again as the European debt crisis lingers. Markets are edgy over EU debt crisis resolution and a slowdown in Chinese growth:

News that China is growing at its slowest rate in two years added to the unease in markets in the run-up to Sunday's meeting.

Though Chinese growth was running at a still strong rate of 9.1 percent in the three months through September, the slowdown comes at a time when other key pillars of the global economy, such as Europe and the U.S. have seen their growth rates slow down sharply as well.

"Given the European Union as a whole is China's largest trading partner, investors are justifiably questioning the ability of Europe to register enough growth to help alleviate its current debt crisis," said Geoffrey Yu, an analyst at UBS. "The soft data added to market woes initiated yesterday."

I personally have given up on European leaders and agree with Carl Weinberg, founder and chief economist at High Frequency Economics, who spoke on Bloomberg television on Monday stating that politicians have to step out of the way and allow technocrats to fix this crisis (see clip below). It's mind boggling that European leaders keep dragging their feet and not biting the bullet.

Meanwhile, over in the US, the Volcker rule is dividing regulators:

The rule would limit most proprietary trading, where a bank places bets for itself rather than for clients, a major money maker for the industry. Wall Street has warned that the rule will eat into profits just as banks are trying to regain their footing.

Anticipating complaints, regulators have already fashioned multiple exemptions to the ban, allowing banks to place trades when hedging against risk. Banks can also buy securities from one client with an eye toward later selling them to another, though the line is often fuzzy between that business and proprietary betting.

The proposal reflects the rule's complexity, spanning nearly 300 pages and taking aim at some of the most arcane financial minutia. Davis Polk, a law firm that advises some of the nation's biggest banks, has churned out multiple summaries of the proposal for clients and even started a Web site, Volckerrule.com.

The regulatory discord, analysts say, only compounds the confusion. While the Volcker Rule itself "would be a worthy study for Talmudic scholars, complicate this with five agencies having to write the rules and you have geometric expansion of complexity," the accounting firm PricewaterhouseCoopers said in a recent report.

Still, regulators are open to tweaking the rule. The proposal posed nearly 400 questions, replete with multiple follow-up queries, for the industry and the public to ponder.

Poor banks, they are not making enough money fleecing customers on fees and their traders are getting clobbered in these volatile markets. Even the great Goldman Sachs, weighed down by problems its private equity portfolio and the broader global economic woes, reported a loss of $428 million, compared with a $1.7 billion profit a year ago. But don't shed any tears for them as some are considering shedding their bank status and I'm willing to bet by the time lobbyists finish watering down the Volcker rule, these new regulations will have more holes in them than Swiss cheese and banking laws, effectively making them completely and utterly meaningless.

Speaking of new regulations, Pensions & Investments reports that groups urge GASB to slow down:

Public pension plan and government employee groups worried about sweeping new accounting rules for public pension plans proposed by the GASB are asking for more time.

In an Oct. 14 letter to the Governmental Accounting Standards Board, 21 organizations — including AARP, the National Conference of State Legislatures and multiple public employer groups — expressed their concern that GASB’s timeline for finalizing its proposal “may be too compressed to properly assess the impact” of the proposed changes and the transition time needed for the new rules.

The GASB first proposed the changes July 8 in two exposure drafts — one for government employers and one for public pension plans — that were designed to bring what GASB Chairman Robert H. Attmore called “more robust disclosure.” The GASB planned to finalize the proposals by next summer, after public hearings and field studies.

One of the biggest proposed changes would have plans highlight their net pension liability on their balance sheets, instead of in the footnotes. That is “a radical departure” from the current practice of reporting annual required contributions, the groups wrote in their letter. “This departure will create much confusion.” While the proposed accounting numbers should not be used to evaluate the funded status or required contributions, “there already has been serious misunderstanding in this area,” and the GASB should at least consider adding a warning in the final rules, the groups argued.

Recognizing the significant financial reporting issues involved, the GASB on Sept. 23 extended its comment period and field studies timeline by two weeks. At that time, GASB spokeswoman Christine Klimek promised further outreach: “The comment period is not the end of the process,” she said.

In a separate letter also sent Oct. 14, 131 representatives of public pension plans in 37 states wrote to express concern about the overall proposed rules. “Everybody is interested in transparency, but the widespread concern is implementation. Employers who have to do this have not gotten engaged to understand what’s coming,” a source familiar with the GASB rulemaking process said.

GASB officials were not available to comment on the Oct. 14 letters.

The Bond Buyer reports that Dems are hitting GASB on pensions:

Two congressmen joined issuers in urging the Governmental Accounting Standards Board to retool or withdraw a proposal that would change how cash-strapped states and localities report pension liabilities, saying the new standards would prove destructive in the current economy.

GASB in July outlined the proposal that would require state and local governments, for the first time, to report unfunded pension liabilities on their balance sheets.

Currently, many governments disclose pension information in the footnotes to their financial statements, and generally only report the contributions they are required to make in a given year, as well as what they actually paid.

GASB said the proposed standards — one for reporting by government employers that provide pension benefits and a second for pension plans that administer the benefits — would lead to “significant improvements” in its pension standards.

But the congressmen and issuers stressed the proposal would subject state and local governments to a new accounting system for which they had insufficient resources and time to prepare.

“While changing accounting standards as you have proposed would be destructive, counterproductive, and unjustified during any economic circumstances, it would be particularly damaging now,” wrote Reps. Gerald Connolly, D-Va.. and Edolphus Towns, D-N.Y., in a two-page letter, dated Aug. 11, to GASB chairman Robert Attmore.

The congressmen said the proposed changes were unnecessary, “given the reliability of most public pension plans and their sponsors.”

Specifically, they said, public pensions over the past 25 years have generated average annual returns of 9.25%, with very low default rates among cities and counties.

“Local governments are managing their money just fine without having arbitrary and destructive new standards imposed on them by GASB,” they wrote.

In addition, Connolly and Towns said GASB’s proposed changes would “impose gratuitous volatility and economic hardship on cash-strapped localities” and likely “exacerbate” existing economic difficulties, particularly for “the smallest governments.”

Issuer groups and issuers echoed these concerns, focusing on one proposed change in particular: a recommendation that public sector plans report net pension liabilities on their balance sheets, not just payment of the annual required contribution, or ARC.

A coalition of 21 issuer, public pension and public sector union groups submitted a joint two-page comment letter, dated Oct. 14, saying this recommendation was a “radical departure from long-held practice.”

Specifically, they said, the proposal would significantly alter how state and local government account for pension benefits and create “much confusion.”

Collectively, the groups — including the Government Finance Officers Association, the National League of Cities, the U.S. Conference of Mayors and the American Federation of State, County and Municipal Employees — said GASB should “clearly and specifically articulate” in its final rules, slated for release in June 2012, that the new accounting measures are not based on, and should not be used for, government pension funding and budgeting.

Separately, the GFOA submitted a comment letter saying it “adamantly opposes” the board’s proposal to “abandon” the ARC as the basis for measuring pension cost.

Such a move “would mark a major step backward,” the GFOA said. In particular, the group noted, “the unfunded actuarial accrued liability is simply too volatile to display as a liability on the face of the financial statements.”

The GFOA also said there was no “cause to jettison” the ARC “in favor of an alternative approach that promises little in the way of information of practical use to actual public-sector decision makers.”

Issuers — large and small — picked up on this theme as well.

Denison, Texas, for example, told GASB the proposed standards would impose “significant expense and reporting burdens” on state and local governments.

Susan Way, the city’s finance director, also wrote that the proposal was “needlessly complex,” would reduce transparency and should be withdrawn.

A large issuer made a similar point, saying the board’s proposal would impede, not enhance, reliability in financial reporting.

In a letter dated Sept. 14, Mark Page, director of New York City’s Office of Management and Budget, wrote that the “first priority” in pension reporting should be to indicate whether a government is “responsibly and systematically” contributing to its pension plans.”

But, Page wrote, GASB’s proposal would shift from “a funding based approach” toward a “'point in time’ estimated measure of a net pension liability.”

Such a measure is “insufficiently reliable” for inclusion on a government’s financial statements and would introduce “volatility” that could obscure a government’s contributions, be they “responsible or otherwise.”

“We continue to believe that an actuarially calculated annual required contribution, based on an acceptable actuarial measurement approach and regularly monitored assumptions is the best available proxy for the burden current period taxpayers should be bearing for current services,” he wrote.

GASB’s proposal would also change the formula states and localities use to convert projected pension benefits into present value, based on an assumed “discount rate.”

Specifically, GASB recommends that pension plans use a historic rate of return — typically 7% to 8% — only to the extent the plan has sufficient assets, set aside in an irrevocable trust, to make projected benefit payments.

When a plan reaches a point of no longer having sufficient assets set aside in a trust for long-term investments, it would have to shift to a so-called risk-free rate of return pegged to a tax-exempt, high-quality, 30-year municipal bond index, typically 3% to 4%.

In its comment letter, the GFOA said it supported the board’s “principled decision” to retain the long-term expected rate of return,” especially in view of criticism “from those advocating the use of a risk-free rate of return.”

The Public Employee Pension Transparency Act, introduced Feb. 9 by Republican Reps. Devin Nunes and Darrell Issa of California and Paul Ryan of Wisconsin, would require state and local governments to determine pension liabilities using a risk-free rate and report them to the federal government. Issuers who failed to comply would lose their ability to issue tax-exempt, tax-credit or direct-pay bonds.

I believe these new accounting rules have some merit but implementation will be difficult if not impossible at this time. The timing of all these regulations is what concerns me. Both CalPERS and CalSTRS, the two largest public pension plans, have asked for a delay in the new accounting rules, which is reasonable given the scope of the proposed changes.

Finally, whether it's new regulations, the EU debt crisis, a "slowdown" in China, I think investors should ignore the noise and keep buying the dips. My favorite leading indicator for the global economy is Google's earnings report and I've had it with all the gloom & doom being spread on blogs like Zero Hedge. Sometimes they post interesting comments but most of it is pure rubbish (which is why they kicked me off and took my blog off their blog roll; shows you who is funding them). Below, I leave you with the clip of Carl Weinberg discussing the EU debt crisis.