Link: “Surviving The Cure For Asset Deflation” by Daniel R. Amerman, FSU Editorial 12/03/2009

Many people would say that the true lesson of the early 2000s in the United States is the demonstration what an extraordinarily loose credit policy can do in terms of asset prices. Low cost and easily obtainable mortgages led to a real estate bubble, even as easy and loose corporate bond markets led to a booming private equity market, with leveraged buyouts being an important factor in maintaining an overvalued stock market.

The problem is that Wall Street, the government, and much of America has effectively bet everything they have on these asset bubbles not only staying inflated, but continuing to expand. Pensions long ago became “the tail that wags the dog”, for state governments, local governments and most major corporations. Almost every state and local government in the US that has full time employees has entered into promises for future benefits, which it anticipates being unable to cover from ongoing tax revenues. Some of these promises are unfunded, others are fully “funded” (meaning they have adequate current portfolios given the investment return assumptions), but the mechanism all comes down to the same thing. Via the mechanism of the markets, vast sums of money and resources will flow from the outside economy into the local economies for all the states and cities, and will pay for the legally binding promises that would otherwise be unaffordable from current revenues. In other words – the asset bubbles have to not only be maintained, but must continue to inflate, or else the pension obligations bankrupt every level of state and local government.

Governments aren’t the only ones relying on asset bubbles, so are most of the major corporations. Oh, the defined benefit plans are disappearing fast in terms of the ability of workers today to participate, but there are still tens of millions of workers covered, and many trillions of dollars of pension and health care benefits that will have to be paid. Future benefits that would destroy corporate profitability, and drive many corporations into bankruptcy.

The government doesn’t control the value of assets, but it does control the value of the dollar. It can do something that actually fools almost all of the people almost all of the time. The government can devalue the dollar. It can create inflation. What the government can do is it can take that hundred thousand dollar asset, that wants to fall to $20,000 in real terms, and let it fall, but still make it worth $200,000 in nominal terms simply by devaluing what each of those dollars are worth. Which means the homeowners are no longer underwater, and the banks are no longer insolvent.

… so long as the purchasing power of money is destroyed faster than the purchasing power of assets, an illusion of asset inflation is created.

An illusion that is potentially deadly for your investments and standard of living for the next several decades – but which is impossible to see through if you take the most common approach to looking at inflation or deflation, which is that it must be one or the other.

…consider the dilemma of the pension funds. It could be the State of California, or your local city government, or just about any major corporation that has been around for several decades. Legally binding promises have been made based on the belief that markets always rise and reliably compound wealth. (I wrote my first book pointing out what an exceptionally bad and historically unsupported idea that was, back in 1993.) So for example’s sake, if the market value of a portfolio doesn’t rise from $35 billion to $50 billion, then the pension sponsor is in serious trouble. Enter asset deflation, and the portfolio goes down to $25 billion, and refuses to go back up. An event that leads to systemic bankruptcy of every level of state and local government and corporation in the United States with major pension obligations.

Unless, as illustrated above, a dollar becomes worth 50 cents. Asset deflation is entirely covered by monetary inflation. Rephrased, the destruction of half of the value of the pension fund (and your) assets is entirely hidden by the destruction of half of the value of your money. Everybody is legally solvent again.

…if you are unwilling to be fooled again, and you are willing to roll up your sleeves and learn, then an unfair world transforms into a world of opportunity. Because here is the real essence of inflation and deflation: they are both REDISTRIBUTIONS of wealth. In each case, and particularly when the two occur together as illustrated in this article – there is a fundamental redistribution of wealth within society. With some people doing much better and others doing much worse.

This fundamental redistribution is more dangerous for some than others. Generally speaking, the higher the degree of monetary inflation and asset deflation, the more the older segment of the population is disproportionately devastated. For the reason that older savers have the savings & portfolios to lose, but lack the decades of peak personal career earnings needed to replace the assets. Which is deeply, totally unfair, but it is the way of the world.

With knowledge, the redistributions can flow to you, rather than away from you. The greater the degree of inflation – the more wealth that fundamental economic forces will redistribute to you. Understand how the redistributions work – and a potentially catastrophic degree of inflation can become the single most financially lucrative event of your lifetime.

But for this to happen, two uncommon steps have to be taken, which will separate you from most of your peers. You have to fully accept personal responsibility for your own future, and say “I won’t be fooled again”. Then you have to make the choice to learn how to turn societal deceptions into personal opportunity.

Individuals whose employer pension is based on a defined benefit plan may want to plan to supplement their retirement income from other sources. The choice of how to save and invest is more complex than ever. These are challenging times for investors and future retirees.

Link: Steep Losses Pose Crisis for Pensions – Washington Post

The financial crisis has blown a hole in the rosy forecasts of pension funds that cover teachers, police officers and other government employees, casting into doubt as never before whether these public systems will be able to keep their promises to future generations of retirees.

The upheaval on Wall Street has deluged public pension systems with losses that government officials and consultants increasingly say are insurmountable unless pension managers fundamentally rethink how they pay out benefits or make money or both.

Within 15 years, public systems on average will have less half the money they need to pay pension benefits, according to an analysis by Pricewaterhouse Coopers. Other analysts say funding levels could hit that low within a decade.

After losing about $1 trillion in the markets, state and local governments are facing a devil’s choice: Either slash retirement benefits or pursue high-return investments that come with high risk.

The urgent need for outsize returns by these vast public pension funds, which must hit high investment targets year after year to keep pace with rising retirement costs, is in turn fueling a renewed appetite for risk on Wall Street.

Before the crisis, many public pension funds had experimented with risky trading techniques or committed more of their money to hedge funds and other nontraditional firms, which in turn invested some of it in complex mortgage securities. When these melted down, pension funds got burned.

Now, facing an even bigger funding gap, some systems are investing in the same securities, betting that a rebound in their value will generate huge returns.

“The amount that needs to be made up is enormous,” said Peter Austin, executive director of BNY Mellon Pension Services. “Frankly, they are forced to continue their allocation in these high-return asset classes because that’s their only hope.”

Some pension experts say the funding gap has become so great that no investment strategy can close it and that taxpayers will have to cover the massive bill.

The problem isn’t limited to public pension funds; many corporate pension funds have lost so much ground that they are also pursuing riskier investments. And they, too, could end up a taxpayer burden if they cannot meet their obligations and are taken over by the federal Pension Benefit Guarantee Corp.

Public systems still have enough to meet their current obligations. If governments take no action, retirees could keep drawing full benefits for the foreseeable future even under the most pessimistic projections.

But already, some funds are seeking to trim benefits to conserve money. Some governments have also proposed increasing the amount of public money paid each year into the funds. In practice, however, some political leaders have begun doing the opposite — cutting annual contributions to pension funds — as a way of balancing state and local budgets buffeted in the recession by falling tax revenue and rising costs.

More Risk or Lower Returns

This is the dilemma confounding pension funds as they emerge from the wreckage of the financial crisis: If they shy away from riskier investments, they would be settling for lower returns that leave future shortfalls unaddressed. But by aggressively pursuing the higher rates of return they need, pension funds increase the chances they will be burned again by investment bets gone bad.

“State pension fund directors face enormous pressure trying to recover their investment losses. It will be tempting for them to consider investments that promise a high rate of return,” said Sue Urahn, managing director of the Pew Center on the States, which plans to release a report on pension losses within weeks.

Traditional investment strategies, which rely on stocks, haven’t fared well in recent years. To meet their obligations to retirees, pension funds tend to assume they will earn an eight percent return on investments each year. The stock market, as measured by the Standard & Poor’s 500-stock index, is actually down 32 percent this decade.

If your employer contributes to a defined benefit plan for your retirement, you may not get what you expect. You might need to consider an alternate plan for saving for retirement.

Link: U.S. Employers Face Huge Pension Funding Tabs Without Relief, Watson Wyatt Analysis Finds

Despite recent increases in asset values and regulatory relief from the Internal Revenue Service (IRS), U.S. employers will be required to contribute $89 billion into their defined benefit (DB) plans in 2010 and more than $146 billion in 2011 unless they receive funding relief from the federal government, according to an analysis by Watson Wyatt, a leading global consulting firm.

“The combination of a deep recession and new pension law has landed employers in extraordinary circumstances, and they need temporary funding relief to lessen the enormous pension contributions required in the next few years,” said Mark Warshawsky, director of retirement research at Watson Wyatt, who testified on these points at an October 1 House Ways and Means Committee hearing.

Watson Wyatt analyzed the projected required contributions for single-employer DB plans under various scenarios: the existing law (including the September 25 IRS guidance) and three legislative proposals currently under consideration.

The analysis found that past relief granted by legislation and regulations had lowered required contributions for corporate pension plans to $32 billion in 2009 from $38 billion in 2008. But without further action, employers’ contributions would explode to more than $146 billion in 2011. Under the three legislative proposals, employers’ contributions would be somewhat lower, by $10 billion to $25 billion annually with different time paths, but required contributions would still be very large.

Without additional funding relief, the average regulatory funded status would decline slightly from 96.4 percent in 2008 to 93.8 percent in 2009, and then fall to 83.8 percent in 2010 and to 76.8 percent in 2011, the analysis found.

…

“A crucial decision lies ahead for lawmakers,” said Gene Wickes, global director of benefits consulting at Watson Wyatt. “Congressional and administration support for funding relief would help ensure that DB plans remain viable for employers and a vital element in the retirement security for workers. It could also save employers from making the difficult choice between large, required pension contributions or jobs, wages and capital investment.”

For the funding analysis, please visit: http://www.watsonwyatt.com/us/pubs/insider/showarticle.asp?ArticleID=22407

For the testimony, please visit: http://waysandmeans.house.gov/hearings.asp?formmode=view&id=8071.

via Michael Panzner at Financial Armageddon

The global pension crisis is really a crisis of modern day capitalism. If we don’t figure out a long-term solution to this crisis, we risk having a new class of elderly poor who were cheated out of their pensions.

Global pension tension will not vanish. We are better off holding a summit to look into pensions and think of ways of bolstering retirement plans for future generations. Waiting for the ‘markets’ to rectify this crisis is like waiting to win the lottery. You might be lucky but who wants to gamble away the retirement dreams of millions of workers?

He offers an excellent review of global pension tension. Excerpts below.

Link: Pension Pulse

• CPP reforms will squeeze early retirees: Big changes to Canada Pension Plan benefits, announced last week, were overshadowed by news of a larger-than-expected federal deficit.
• N..B. Investment Management Corp. reports pension funds fall 18.3%: The province’s pension plans suffered an 18.3 per cent loss last year due to the dramatic decline in global equity markets, according to the New Brunswick Investment Management Corp. The value of net assets under management shrank by $1.6 billion in fiscal 2008-09, finishing the year with $7 billion.
• Air Canada unions may seek stake in pension talks: Air Canada’s unions will be looking for some concrete financial guarantees to backstop their pensions, including the possibility of taking a stake in the airline, when they collectively meet with management later this week to determine whether they will support a moratorium on their pension payments.
• Iberia says BA pension very important to merger: Iberia and British Airways have no pre-determined deadline to complete merger talks, the Spanish carrier said on Wednesday, but added it was closely watching what burden BA’s pension fund would impose as part of the merger process.
• BP and Barclays Propose Pension Restrictions to Cut Expenses: BP, Europe’s second-largest oil company, will close its final-salary pension plan to new U.K. workers, and Barclays Plc may ask 18,000 employees to give up similar benefits that the bank says have become too costly.
• Crunch ‘an excuse to cut pensions’: The joint leader of the UK’s biggest trade union has accused employers of using the recession as an excuse to permanently cut pensions. Derek Simpson of Unite said the union would back workers if they decided to stand up to firms which were “hell bent” on eroding pension benefits. Mr Simpson expressed “outrage” at a series of announcements in recent days, including a move by Barclays to shut its final salary pension scheme to further contributions from existing members.
• Paterson Vetoes Pension Guarantee for N.Y. Police, Firefighter: New York Governor David Paterson vetoed a bill that would prevent newly hired police and firefighters from getting less generous pension benefits than their senior colleagues, ending a guarantee the Legislature had extended for almost 30 years.
• Delphi Salaried Retirees To Lose Pension Benefits: For these salaried retirees — and thousands more like them — the latest news from Delphi only adds more insult to injury. The bankrupt parts-maker now wants to get rid of its under-funded pension plan for former white-collar workers — meaning the federal Pension Benefit Guarantee Corporation will take it over.
• Hungary struggles to rein in runaway pension costs: The country’s poor demographics, failed reform, heavy and ineffective taxation, a skewed labour market and heavy debt burden all threaten the system with collapse and require quick action, analysts say.
• Network Rail pension deficit swells by 80%: The owner of Britain’s rail system has seen its pension deficit nearly double after a 25 per cent fall in the value of its assets.
• ECB Staff Plan Strike Over Pay, Pension Terms: European Central Bank union staff are planning the first labor action in the ECB’s 10-year history by walking off their jobs for 90 minutes on Wednesday. Union leaders warn that unless they get more of a say over how pensions and pay are set, there could be more.
• UK faces ‘lost generation’ of pension savers: Many young people are failing to understand how much they need to save to maintain their standard of living in retirement – and are just choosing not to retire.
• Another watershed for final salary pensions: Dr Ros Altmann is a former adviser to No. 10 on pensions. Here she explains that while private sector final salary schemes are finished, public sector schemes remain underwritten by the taxpayer.
• Finally, McGuinty says he can’t understand Harper’s refusal to talk pension reform: Prime Minister Stephen Harper’s refusal to hold a national summit on pension reform is baffling, Ontario Premier Dalton McGuinty said Tuesday as he predicted the issue would be intensely debated at the annual premiers’ meeting in Regina this summer.

If your pension provider is in financial trouble, you may not have the retirement income you had planned on.

Both private and public decision makers who pass the buck to future decision makers have created a legal and financial nightmare for all concerned.

This is an example of how the financial crisis has expanded the retirement crisis.

Link: CNNMoney, Fat Pensions Spell Doom For Many Cities

For years, politicians have been playing what amounts to a multi-trillion-dollar shell game with state and local pensions. They’ve doled out lush retiree benefits to their heavily unionized workforces, knowing that they could shove the cost for those benefits onto future generations of taxpayers.

But a recent financial bombshell dropped by a San Francisco suburb shows why that shell game is now starting to unravel in a nasty way. And it’s a cautionary tale that you can’t afford to ignore.

Here’s the skinny: In late May, Vallejo, Calif., became the largest city in California history to declare bankruptcy. Its financial demise was brought about partly by the real estate crash, which decimated home prices in the area and put a major dent in the city’s tax revenues.

… The final budget-crusher was the city’s pension plan. Thanks to retroactive benefit enhancements approved by the city council in 2000, police officers and firefighters can now retire at age 50 and receive an annual pension equal to 90% of their final pay (assuming 30 years on the job), an amount that gets increased every year to help keep pace with inflation. The old plan had given the workers a pension equal to 60% of their final pay at age 50.

So a Vallejo police sergeant making $150,000 a year can now retire at age 50 and receive an annual pension of $135,000, increased each year for inflation. To put that amount in context, you would need to amass a retirement nest egg equal to about $3.5 million to produce a similar retirement income on your own.

It wasn’t just police and firefighters who benefited from the city’s largess. The annual pensions for rank-and-file city employees were jacked up from 60% of final pay at age 55 (after a 30-year career) to a whopping 80% of pay, increased each year for inflation.