Thanks to Bernanke’s efforts to push down interest rates by flooding the world with dollars, companies have gotten the not-so-brilliant idea to borrow money to fund their pension plans, hoping returns will exceed their borrowing costs.
Please consider UPS Fights ‘Fire With Fire’ to Fill Pension Gap
Companies facing the biggest pension deficit since at least 1994 are selling bonds at the fastest pace in more than seven years to plug the hole, betting that future returns will exceed their borrowing costs.
United Parcel Service Inc., the world’s largest package- delivery business, Dow Chemical Co., Northrop Grumman Corp. and PPG Industries Inc. sold at least $5.25 billion of investment- grade U.S. corporate bonds in November to fund their pensions, making it the busiest month since June 2003, according to data compiled by Bloomberg.
The Federal Reserve’s effort to hold down interest rates to stimulate the economy has caused corporate pension obligations, which are pegged to bond yields, to rise by $105.8 billion this year to $1.44 trillion as of October, according to Milliman Inc. Now, companies are taking advantage of borrowing costs at about the lowest on record as Goldman Sachs Group Inc. says interest rates will rise as the global economy recovers.
“They’re fighting fire with fire,” John Lonski, chief economist at Moody’s Capital Markets Group in New York, said in a telephone interview. “They’re being victimized by low bond yields, so why not go ahead and use them as an offset?”
Few, if any, borrowers have had their credit ratings cut for issuing debt to fund pension obligations, Lonski said.
Yields may not move substantially higher over the next several years, he said. “They’re willing to make a gamble that future returns will exceed the current cost of debt,” he said.
“If you truly believe that rates are going up, you should be issuing debt,” said Gordon Latter, a managing director at RBC Global Asset Management in Minneapolis. Latter said his firm is proposing that clients issue bonds to help fill pension deficits.
You do not borrow money to invest just because rates are going up. There’s a set of not so insignificant factors including expected rate of return as well as risk management that should come into play.
After this massive rally in equities, commodities, and bonds, cheerleaders think speculating in the markets is a good idea. It could work out, but it’s extremely foolish.
Equity prices in the US are priced for perfection if not far beyond perfection, China is tightening, a slowdown in Europe is inevitable, and commodities have been on fire but will likely come under stress because of China and Europe.
Moreover, state cutbacks are coming, and as many as 2 million people will lose all source of income unless Congress approved a benefits extension in the lame-duck session.
I can hardly conceive of a worse backdrop in which to go into debt for the sole purpose of betting on the market, yet that is the advice given. Just what are those companies supposed to do with the cash they raise from bond sales?
I suspect nearly all of it will go into long-this-long-that strategies. If correct, I smell a disaster for the borrowers.
But hey, Wall Street will win twice, first on underwriting the bond deals, then on fees to manage the investments. It’s a sweeeet deal, for someone, namely those handing out poor advice.
Video Reveals Gimmicks Used by CalPERS to Hide The Decline in Assets
Inquiring minds are reading California State Pension System Makes Madoff Proud by Gwilym McGrew
Much has been written about The California Public Employees’ Retirement System (CalPERS) being underfunded by $500 billion due to massive investment losses over the last decade, but now we have video of a CalPERS Senior Pension Actuary, Kung-pei Hwang, describing how they intend to change basic assumptions in their financial model to (please allow me to mix my metaphors) Hide The Decline in their assets held for municipal, county, and state employee’s retirement.
Through this statistical gimmickry, CalPERS can push the loss into later years and appear solvent today. Of course, at some point in the future it will need to raise funds from state and local governments to compensate for these losses. But for now, they seem content to hide the disastrous condition of their fund.
As you can hear Mr. Hwang say in his presentation to the Huntington Park City Council last week, “that means we will defer most of the loss to future years.” “This means the city will realize another increase in future years. I hate to bring bad news, but those are the facts.” Well, the fact is this bad news will hit budgets for all cities, counties and the state of California and not just Huntington Park. By playing with its financial model in this way, CalPERS is treating all California taxpayers like Madoff investors by cooking its actuarial books to Hide The Decline in its assets.
The video in the above link is somewhat hard to understand. However, Gwilym McGrew details exactly what CalPERS is attempting to get away with via various “smoothing” and “re-smoothing” extend-and-pretend operations that are doomed to fail.
Mike “Mish” Shedlock
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