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PUTIN AGREES WITH TUCKER CARLSON

Putin says U.S. and allies blew up Nord Stream pipelines

Sept 30 (Reuters) - Russian President Vladimir Putin on Friday directly accused the United States and its allies of blowing up the Nord Stream pipelines.

"The sanctions were not enough for the Anglo-Saxons: they moved onto sabotage," Putin said. "It is hard to believe but it is a fact that they organised the blasts on the Nord Stream international gas pipelines."

"They began to destroy the pan-European energy infrastructure," Putin said. "It is clear to everyone who benefits from this. Of course, he who benefits did it."

A sharp drop in pressure on both pipelines was registered on Sept. 26 and seismologists detected explosions, triggering a wave of speculation about who might have sabotaged one of Russia's most important energy corridors.


The European Union said it suspected sabotage caused the damage to the Gazprom-led Nord Stream 1 and 2 pipelines in Swedish and Danish waters. The White House has dismissed Russian allegations it was behind the incidents.

Russia's top spy said that Moscow had intelligence indicating that the West was behind what he said was a "terrorist act" against the pipelines. (Reporting by Reuters; editing by Guy Faulconbridge)

What's happening with the Nord Stream pipelines?

Joel Mathis, Contributing Writer
Fri, September 30, 2022 

A pipeline. Illustrated | Getty Images

Somebody has sabotaged the Nord Stream pipelines.

At least four leaks have appeared in the pipelines — both Nord Stream 1 and Nord Stream 2 — that are used to carry gas through the Baltic Sea from Russia to the rest of Europe. On Thursday, NATO formally declared the leaks to be an act of sabotage. "Any deliberate attack against Allies' critical infrastructure would be met with a united and determined response," vowed NATO Secretary-General Jens Stoltenberg.

So who did it? And why? Some fingers are pointing to Russia — and Russia is pointing fingers right back. All of this is going on amid Russia's war against Ukraine, of course, as well as a European energy crisis stemming from that war. What will the Nord Stream leaks mean for a continent in crisis? Here's everything you need to know:

What are the Nord Stream pipelines?

They don't carry all of Russia's natural gas exports to Europe, but they do carry a lot of it. They're owned by Gazprom, the giant Russian energy firm. The first pipeline was announced in 1997 and became operational in 2011, CNN reports. "For the past decade, it has been a key artery carrying Russia's vast gas supplies to Europe, accounting for about 35 percent of Europe's total Russian gas imports last year." The second pipeline was completed last year, but just as it was about to go into operation, Russia invaded Ukraine — and Germany shut the whole thing down.
Was it controversial before the war?

Absolutely. CNBC reported in 2019 that while the pipelines were seen by Europeans as a "sustainable way to ensure European energy security," there were many observers — particularly in the United States — who worried that "Germany's dependence on Russian energy … could make it susceptible to exploitation and more vulnerable to interference." Then-Energy Secretary Rick Perry warned that "Russian gas has strings attached," and Sen Ted. Cruz (R-Texas) was a vocal advocate of imposing sanctions on the second pipeline long before Russia invaded Ukraine.

"Putin's end game is his assured stranglehold over the European energy market," Cruz said in 2020. That would "allow Putin to hold winter energy supplies hostage for the ransom of European Union political deference."

What has happened since the war started?

The worries were justified. Even as European nations have cut off Russia's access to their markets, they've tried to avoid a complete cutoff of energy supplies, but that hasn't really worked out. In April, Russia cut off gas deliveries to Poland and Bulgaria, "cranking up retaliation for Western sanctions imposed for Moscow's invasion of Ukraine," Reuters reported. Then in July, Russia entirely stopped gas deliveries through the Nord Stream 1 pipeline for 10 days, ostensibly for maintenance, before announcing an indefinite shutdown earlier this month.

From that standpoint, the situation is unchanged: Europe already wasn't getting gas from Russia through the pipelines. But it does add uncertainty to an already tense situation.

Winter's coming. How will Europe get through?

Things are volatile.

The tightening of gas supplies from Russia has raised prices and put a massive strain on the continent. "High energy prices are lashing European industry, forcing factories to cut production quickly and put tens of thousands of employees on furlough" and raising the risk of recession, The New York Times reports. In Britain, the national energy regulator announced in August that "U.K. residents will see an additional 80 percent increase in their annual household energy bills." And AP reports that this week, "thousands of protesters rallied again in the Czech capital on Wednesday to condemn the Czech government's handling of the energy crisis and its support for Ukraine."
So if the Nord Stream pipelines were attacked, who did it?

"The short answer is: We don't know, and we won't know for some time," Emma Ashford, a columnist at Foreign Policy, said in a Twitter thread that lays out a number of possibilities. But there is a ton of speculation.

On Fox News, Tucker Carlson made the case that the United States did it, and that it might prompt retaliatory attacks from Russia. (Pro-Putin Russian TV commenters loved that.) A Russian official said the attack "looks like an act of terrorism, possibly on a state level," and suggested the United States might be the beneficiary. Poland and Ukraine blamed Russia, the Times reports, while others suspect "Ukraine or one of the Baltic states, which have long opposed the pipelines, might have had an interest in seeing them disabled." Meanwhile, European security officials say Russian Navy ships were spotted in the area shortly before the pipelines started to leak. What is clear is that nobody — whether or not they're responsible for the sabotage — wants to take the blame.

So what does all this mean for Europe and the war in Ukraine?

There are all kinds of consequences, both in the short-term and the long. Just one example: The gas leaks have been labeled a "climate disaster" because they've released 300,000 metric tons of gas into the atmosphere.

Meanwhile, "the extent of the damage means the Nord Stream pipelines are unlikely to be able to carry any gas to Europe this winter even if there was political will to bring them online," Al Jazeera reports. That could end up being a permanent situation. "Europe is trying to move away from Russian gas, and they'll never again view Russia as a reliable supplier," the Brookings Institution's Samantha Gross tells Slate. This winter, she said, Europeans will probably be forced to put on sweaters and turn down their thermostats: "There's no question — pipeline or no pipeline, accident or no accident — that Europe is facing a real gas crisis this winter."

WORKERS CAPITAL

U.S. pension rebalancing could boost bonds,

 international stocks, banks say

David Randall
Thu, September 29, 2022 


U.S. currency is seen in this picture illustration

NEW YORK (Reuters) - U.S. fixed income and international equities could benefit from quarter-end rebalancing as pension funds square their books after a brutal three months for most asset classes, according to estimates from several Wall Street banks.

Overall, Credit Suisse expects pension funds to buy $30 billion worth of developed market equities and another $15 billion in emerging markets while trimming U.S. large-cap consumer discretionary stocks.

"September has been rough on most asset classes, but on a relative basis, the US has fared better than its international peers," analysts at the firm wrote in a Thursday report.

Wells Fargo, meanwhile, expects pensions to move $10 billion into U.S. fixed income as the group's mean funded ratio - a projection of the gap between a fund's assets and its future liabilities - rises to 107%, near its peak for the year.

Wall Street pays close attention to quarter-end moves by pension funds given their potential outsized market influence. Overall, U.S. state and local pension funds have $5.12 trillion in assets under management, according to data from the Federal Reserve, and often rebalance each quarter to maintain consistent asset allocations.

This year's market swings have presented a challenge to asset managers looking to square their portfolios against a benchmark or return to their long-maintained allocation of stocks versus bonds. The S&P 500 is down 4.6% in the third quarter and has lost 24.2% year to date, while the U.S. bond market - as measured by the $80.3 billion Vanguard Total Bond Market Index fund - is down 3% over the quarter and 14% for the year.

The twin declines in U.S. stocks and bonds this quarter will dampen the overall market effect of investor rebalancing compared to prior periods given that allocations are likely stable, said Marko Kolanovic, chief global market strategist at JPMorgan, in an email to Reuters.

"Stocks are underperforming bonds and other assets - e.g. alternatives - so there could be a bounce 1-2% in stocks given the current low liquidity environment," he said.

(Reporting by David Randall; Editing by Kirsten Donovan)

Pension Rebalancing Threatens to Spur $26

Billion Equity Selloff

Vildana Hajric and Denitsa Tsekova
Thu, September 29, 2022



(Bloomberg) -- US stock investors looking for anything that could halt the rout might not be able to count on a source of support that’s buoyed markets in the past: portfolio rebalancing.

Every quarter- and month-end, pension funds and other institutional investors check their market exposures to make sure they meet strict allocation limits between equities and bonds, as well as between domestic and international stocks. Even amid a global rout, US equities still outperformed many other asset classes, leaving portfolio managers needing to cut their exposure.

When September wraps up, pension funds could be done selling roughly $26 billion in equities thanks to that relative outperformance, according to a Credit Suisse Group AG model.

That’s bad news for anyone who’d hoped buying from that past source of support could act as a lift this time around too. In the last two quarters, the rebalancing by the world’s biggest money managers revived equities by bringing $250 billion into stocks in June and $230 billion in March, according to estimates by JPMorgan Chase & Co.

The S&P 500 lost as much as 2.7% on Thursday as market sentiment soured amid concerns about inflation and the global economy. While the index has slumped 3.7% in the third quarter, global equities have fared even worse, dropping 5.6% with emerging-market stocks falling roughly 12%.

That could give international stocks a boost as Credit Suisse expects buyers to snap up about $46 billion in non-US equities, with $16 billion of that tied to emerging markets. The bank warns the timing of trades could vary dramatically on market sentiment and regularly scheduled cash flows, among other pressures.

Don’t expect the historically stabilizing force of the target-date funds (TDFs) to lead to the usual “miraculous quarter-end stock market rallies,” said Vincent Deluard, a macro strategist at StoneX Financial Inc.

“Equities have outperformed bonds this quarter so the TDF whale should not save the stock market this week,” he wrote

©2022 Bloomberg L.P.

UK government bond tumult ripples into US and European markets

Madeleine Bruder

 

Turmoil in UK government debt has sent shockwaves through global markets, sparking big swings in US and European bonds.

“Bond markets are always highly correlated, but we’ve definitely seen the tail wagging the dog this week,” said Dickie Hodges, head of unconstrained fixed income at Nomura Asset Management. “The moves in gilts were so big that they filtered through to European and US bond markets.”

The 10-year US Treasury, the benchmark in the world’s biggest and most important debt market, on Wednesday posted its biggest one-day rally since March 2020 after the Bank of England announced emergency bond purchases to halt the freefall in UK government debt. Those gains followed heavy losses for global bond markets since last Friday as the heavy sell-off in gilts spread around the world.

Analysts and investors say some of the moves in Treasuries or German Bunds have been caused by leveraged investors — who use debt to amp up their gains and losses — dumping easily tradeable assets elsewhere in order to cover their losses in the UK. But the similar — albeit much more muted — moves in the US and Europe are also down to the shared challenges facing most big economies of how to tame runaway inflation without choking off economic growth.

“Even though the UK is a basket case of its own making, the fact is the same pressures are being acutely felt elsewhere,” said Richard McGuire, a rates strategist at Rabobank. “Investors see the government’s ill-conceived experiment, and wonder if it’s a sign of things to come in other countries.”

Following chancellor Kwasi Kwarteng’s £45bn package of tax cuts and energy subsidies last Friday, traders swiftly priced in a steeper rise in UK interest rates, betting that the BoE would need to tighten monetary policy faster in order to offset the inflationary effects of the fiscal stimulus. Eurozone markets also added expectations for an extra European Central Bank rate increase over the coming year “in sympathy,” said McGuire. He added that his clients, who invest in eurozone sovereign debt, currently have the UK at the top of their list of questions.

The global alignment of monetary policy has also meant that when one central bank changes direction, like when the BoE this week decided to delay its quantitative tightening process, it raises questions about whether other central banks will follow suit.

“In the US market we’re a bunch of single-celled monkeys. You see the Bank of England ending quantitative tightening suddenly and you think that maybe the US will end quantitative tightening too,” said Edward Al-Hussainy, a senior interest rate strategist at Columbia Threadneedle.

The aftershocks of the UK crisis have been particularly evident in the US because of the volatile state of markets more broadly, said analysts and investors. The US and UK, among central banks globally, are raising interest rates at a rapid rate, which has created unusual price swings, even in markets that are typically ultra-stable, like Treasury bonds. Two- and 10-year Treasury notes are both on track to record their biggest sell-off on record this year.

A significant reaction in markets is to be expected, given the historic shift in monetary policy this year. But those moves have also been exacerbated as the uncertainty about the future direction of monetary policy have pushed more cautious investors on to the sidelines. With fewer investors in the market, price swings become even more dramatic, a phenomenon some investors have described as a “volatility vortex.” 

“In higher volatility moments, everything becomes correlated,” said John Briggs, head of US rates strategy at NatWest Markets.

“Even though what is going on in the UK, objectively, shouldn’t have any impact on the Fed outlook or inflation, the fact is that when markets move to that degree, no one is going to be immune. Volatility begets volatility,” said Briggs.

Two Fed officials this week have indicated that the crisis in the UK could potentially create problems for the US. Raphael Bostic, president of the Atlanta Fed said that the UK’s tax plan and the ensuing market volatility could increase the chances of tipping the world economy into a recession. New Boston Fed president Susan Collins also said that “a significant economic or geopolitical event could push our economy into a recession as policy tightens further.”

“There is money moving back and forth that keeps various national markets in line with one another,” said Gregory Whiteley, portfolio manager at DoubleLine. “It is natural spillover as money moves between markets to take advantage of changing prices.”

Five lessons from Britain’s bad week

Madeleine Bruder

This article is an on-site version of our Unhedged newsletter. Sign up here to get the newsletter sent straight to your inbox every weekday

Good morning. Yesterday, we avoided writing about the UK’s fiscal/financial/economic car crash, pleading that we were simple provincials focused on the American colonies. Readers wrote to say this was a dumb excuse for avoiding the biggest story in markets. We fold. Email us: robert.armstrong and ethan.wu.

Also, Monday will bring another collaborative edition of Unhedged, this time on Japan. We’re excited.

The mess in the UK

Financial journalists know that something has probably gone badly wrong when they have to learn a new acronym. This week it was LDI.

Liability-driven investing is a niche concept from the pension industry, of particular importance in the UK. But as much fun as it is to blame feckless pension managers or witless politicians, nothing about this week’s crackup is intrinsically pension-specific or British. It is exactly the type of event one expects at moments like this — at the end of a long bull market, with financial conditions tightening and growth slowing. So, lesson number one:

1. The LDI near-catastrophe was not a one-off

Here is what appears to have happened with pension funds and the gilt collapse this week:

• Some big UK pension plans had a lot of long-term liabilities.

• The plans didn’t have enough money to buy long-term government bonds that closely matched all their liabilities — because bond yields have been miserably low for years.

• The plans therefore bought things with higher expected returns than bonds, such as equities.

• This put the plans at risk for asset-liability mismatches. If interest rates fell — that is, if bond prices rose — the value of their liabilities will rise. Their equity (or whatever) assets might not rise at the same time, leaving them in a badly unfunded position on their next accounting statement.

• So the plans signed derivative contracts, under which they would receive money from their counterparties when bond prices rose and pay money to those counterparties when bond prices fell. These were probably some flavour of receive-fixed pay-floating swaps.

• A while later, UK chancellor Kwasi Kwarteng, dumped a petrol can of unfunded tax cuts on to the UK’s inflationary fire. UK gilt prices fall a lot. The plans now had to pay a lot of money.

• To raise this money, the plans had to sell whatever’s handy. Gilts were one of the handy things.

• Gilts fell more. More margin calls followed. More selling. Finally, the BoE was forced to intervene.

The key feature of this sorry tale is that some financial institutions had de facto or actual financial leverage that did not seem to be particularly risky to them, or to almost anyone else. This time around the leverage took the forms of those derivatives. They may have thought: what are the chances of gilt yields moving more than a full percentage point in a few days? Why, that’s a six-sigma event (or whatever)! Hidden leverage of this sort grows, like black mould in a basement, during long placid periods in markets. Low interest rates also provide a humid environment for financial fungi to grow. More floorboards will be ripped up, and more mould will be found, before this policy tightening cycle ends. Relatedly:

2. Stressed markets are non-linear markets

We learned in the great financial crisis that financial market outcomes are not normally distributed — not when it counts, anyway. The point was repeated in research reports, articles, books, movies and bumper stickers. But before long we all default to thinking in terms of average annual performance, standard deviations and so on. We just can’t help it. Well, friends, tail risk is back. How many UK investors were positioned for 30-year gilts to rise 121 basis points in three trading days? Investors who can’t handle high volatility — say, middle-aged journalists with big mortgages and twins who will be in college in a few years — should think about cutting risk now.

3. Central banks want to fight inflation, but they have other priorities, too

The Bank of England’s (temporary) resumption of bond-buying shows that the fight against inflation is conditional. It is stunning that the central bank would buy bonds with UK headline inflation at 10 per cent. It nodded to this awkward fact in a statement issued by the BoE financial policy committee (notably, not its Monetary Policy Committee):

Were dysfunction in [the long-dated gilt] market to continue or worsen, there would be a material risk to UK financial stability. This would lead to an unwarranted tightening of financing conditions and a reduction of the flow of credit to the real economy …

These purchases will be strictly time limited. They are intended to tackle a specific problem in the long-dated government bond market.

This mini-QE is supposed to last two weeks and, if it goes no further, the ultimate impact on UK inflation will probably be small. But if the gilt market remains unsteady, the BoE could end up removing monetary stimulus with one hand (through higher rates) while adding to it with the other (through bond-buying). In other words, the cost of stopping a financial meltdown is higher longer-term inflation risk. Relatedly:

4. Another developed economy is using yield curve control, or at least an impromptu version of it. Others could follow

By pinning down long rates while not backing down from further short rate increases, the BoE is dabbling in yield curve control. It hasn’t gone full Japan; there is no explicit long yield cap. But the move will revive the argument over whether YCC should be part of the central bank toolbox. Over at Free Lunch (subscribe here), the FT’s Martin Sandbu has made the case:

If financial markets are so sensitive to moves in longer-term government bonds, then why should central banks not focus more on controlling those rather than the short rates? We know two things. First, that if monetary policy controlled long yields, changing them gradually as the macroeconomic picture required, this week’s UK pension funds debacle would not have happened. Second, that central banks can choose to target long rates: the Bank of Japan has, for years, demonstrated how. Other central banks have adopted Japanese policies before. It seems time to consider doing so again.

This makes Unhedged nervous. True, Japan’s experience with YCC has not looked catastrophic. But Japan is Japan; its circumstances are sui generis. In a different context, might YCC, basically open-ended QE, drive private capital out of government bond markets and fuel speculative excess elsewhere? How much the unwinding of QE has frazzled US Treasury markets hints at another unappreciated risk: the process only works smoothly and predictably in one direction. Any unforeseen consequences may prove hard to undo.

5. End-of-an-era arguments just got a little stronger 

Some people think that after the current inflationary incident is over, we will return to what was once called “the new normal”: low inflation, low growth, low rates, low volatility, high asset prices. Other people think that the pandemic only hastened the end of this pleasant economic regime. They argue it was doomed anyway, driven by demographics, global politics, the energy transition and huge accumulation of debt. Unhedged has written about this debate a number of times.

One leg of the fin-de-siècle argument is that, under demographic, political and financial pressure, governments will resort to fiscal as well as monetary excess, pushing inflation and rates up and asset prices down. The argument was articulated by Albert Edwards of Société Générale, with characteristic flourish, a few days before the Truss budget came out:

Until recently, economic ideology had prevented [politicians] breaking free from fiscal austerity. That had caused central bankers to fill the economic void with super-expansionary monetary policy. Those days are now over and aggressive fiscal activism reigns supreme, most visible currently in the UK. This will bring higher growth, higher inflation, and higher interest rates across the curve. The party for investors is over.

It is easy to laugh off the so-called perma-bears who have argued (for as much as a decade) that the post-financial crisis financial settlement was unsustainable and would end in tears: Edwards, John Hussman, Nouriel Roubini, Jeremy Grantham, and a few others. But if we do get a crash, they will be forgiven for being early. And the events in the UK this week fit nicely with their dreary prognostications. (Armstrong & Wu)

WORKERS CAPITAL
Are California's public pension funds headed for another crisis?


Laurence Darmiento
Thu, September 29, 2022

(Daniel Fishel / For The Times)

Vladimir Putin's invasion of Ukraine was shock enough for pension funds holding Russian assets, suddenly worth little.

Then, the prolonged conflict and lingering pandemic drove inflation to heights not seen in 40 years — raising interest rates and putting an end to a decade-long bull run in stocks, the biggest driver of pension fund gains.

The collateral damage wrought by the disruption as well as fears of a protracted recession are now raising questions about the finances of the multibillion-dollar systems relied upon by more than 4 million California public workers to carry them through their retirement.


The California Public Employees' Retirement System, or CalPERS, the nation's largest state pension fund, experienced a 6.1% investment loss in the fiscal year that ended June 30. It was the first annual loss since the Great Recession for the fund that provides pension benefits to employees of the state and nearly 2,900 counties, cities, special districts and other public employers. Assets fell to $440 billion after topping $500 billion last year.

The California State Teachers' Retirement System, or CalSTRS, the nation's largest teachers' pension plan, lost 1.3% last fiscal year, its first decline too in more than a decade.

And things may not get better anytime soon.

Growth in advanced economies is expected to drop sharply from 5.1% in 2021 to 2.6% this year, according to a forecast released this summer by the World Bank that is 1.2 percentage points lower than its January projection — leading to worries that lackluster market returns may extend indefinitely.

In California, current and retired employees covered by CalPERS, CalSTRS and other public-sector pension plans have some of the nation's best protection against such downturns.

A set of related court decisions called "the California rule" guarantees, with only rare exceptions, that the benefits promised to a public employee the day they begin work are the same ones they will get the day they retire.

However, new workers entering public service can be governed by a less generous set of retirement formulas due to issues such as prior unfunded pension benefits, a public agency's own fiscal shortfalls or tough economic times.

Stocks have produced investment gains for some four decades amid deregulation, the tech revolution and rising global trade, powering through market downturns and the twin cataclysms of the tech bust and financial crisis. But some economists are not as sanguine about a recovery this time around.

NYU economist Nouriel Roubini, who famously forecast the 2008 financial crisis, believes that massive debt loads built up during the pandemic combined with high interest rates will lead to an era of low growth similar to 1970's stagflation. In his new book "MegaThreats," he cites deglobalization, protectionism, climate change and other longer-term threats to the world economy.

Ed Leamer, the former longtime director of the UCLA Anderson Forecast, said investors tend to forget that the stock market can produce mediocre returns for years on end.

"There are long periods of time when equities like the S&P 500 don't give you any return at all. If you purchased the S&P in 1970 after their great experience of the '60s, you weren't back at that same level until 1990 — 20 years later," he said.

While the California rule shields current and retired employees from attempts to balance budgets through benefit cuts, it can amp up the financial burden on public employers to make up the difference when real investment returns fall short. That can result in service cuts or layoffs.

Pension costs played a role in the 2012 bankruptcy of Stockton, though governing officials also were accused of incompetence. By the time the city filed for bankruptcy, it had slashed its police force by a quarter, cut nearly a third of its Fire Department and reduced pay and benefits to all employees.

It's projected that this year alone the market downturn will lead to a decrease in the funding ratio of pension plans nationwide from about 85% in 2021 to about 78%, according to Equable, a pension fund think tank. The metric is a key barometer of funds' financial health, measuring the ratio of assets to promised benefits. A lower ratio signifies a greater sum of unfunded retirement benefits.

In California, the cumulative assets of 18 of the largest pension funds are expected to drop this year from $1.37 trillion to $1.09 trillion, lowering the funding ratio from 86.8% to 79.6%, according to an update of Equable's annual report on the state of pensions, titled "The Era of Volatility: Asset Shocks, Inflation and War." A pension fund's ideal target is full funding, or a 100% ratio, which the plans last reached cumulatively in 2007 just before the financial crisis.

Indeed, the financial crisis proved to be a pivotal event for the state's pension systems, some of which had bestowed lavish benefits to employees due to the run-up in tech stocks in the 1990s. The good times didn't last.

First came the tech bust and then the bottom fell out of the market during the housing and financial crises, causing big losses. It all led to major reform in 2013 called the California Public Employees' Pension Reform Act. In addition to setting up a mechanism to pay for past unfunded benefits, it attempted to reduce statewide pension costs by up to $55 billion going forward.

The law targeting new employees did away with acknowledged abuses such as "pension spiking," a practice by which an employee's final salary — a key part of the formula for determining retirement benefits — is artificially hiked by last-minute bonuses, raises or other dubious compensation.

More broadly, it set a normal retirement age of 62 for non-safety employees, made the formula for calculating benefits less generous and placed caps on the final compensation figure that could be used to make that calculation. It also required new employees to pay half of the projected costs of their benefits.

(A majority of state pension funds are subject to the law, a major exception being cities with their own charters and pension plans such as San Diego and Los Angeles. The Los Angeles City Employees' Retirement System lost 7% this past fiscal year, shrinking its portfolio to $20.6 billion, according to a performance report.)

The mandating of less generous benefits for new workers by the 2013 legislation echoed what was already a common practice at the local level.

The Los Angeles County Employees Retirement Assn., the nation's largest county pension fund with more than 180,000 members and retirees, has multiple benefit tiers. The first, Plan A, covers members hired through Aug. 31, 1977, while the last, Plan G, governs those hired on or after Jan. 1, 2013, and incorporates the state's 2013 reforms.

Employees in Plan A were eligible for maximum benefits as early as age 62 with the final annual retirement compensation based on the highest average monthly salary during a consecutive 12-month period of service. The plan would provide a worker making $50,000 with 25 years of service $18,440 in annual retirement compensation. Under Plan G, the state reforms slash that worker's annual retirement compensation to $12,500, according to LACERA calculations.

In announcing its poor returns for this past fiscal year, CalPERS highlighted the volatile global financial markets, geopolitical instability, interest rate hikes and inflation. It noted its investments in global stocks were down 13.1% and even bonds and other fixed income securities — traditionally safe havens in tough times — were off 14.5%.

But the fund also celebrated how its investments in private equity and other private asset classes such as real estate gained more than 20%, offsetting some of the public-market losses, though those figures didn't include the difficult second quarter because of a lag in reporting such returns.

“We’ve done a lot of work in recent years to plan and prepare for difficult conditions,” CalPERS Chief Executive Marcie Frost said in a statement, adding that "members can be confident that their retirement is safe and secure.”

But it's unclear whether in a prolonged downturn the fund can count on private markets to make up for lagging public market investments, which together made up 79% of its investment portfolio.

Private equity firms typically buy underperforming companies, improve their profitability and sell them for gains shared with investors. CalPERS' investment in private equity returned 21.3% as of March 31. But such returns are predicated on rising private company valuations, which could decline amid the surge in interest rates and the fall in stock market valuations of public companies. One prominent private equity investor, Gabriel Caillaux of General Atlantic, has talked about a "crisis of value" as 14 years of ultra-low interest rates suddenly end.

If private equity returns were to turn south, CalPERS risks a replay of its experience with hedge funds, privately run investment pools that use high-risk strategies and market plays to make big returns but that also can experience big losses. The retirement fund dumped its hedge funds as a strategic asset class in 2014 after 12 years of disappointment over their fees, complexities and returns.

Jean-Pierre Aubry, the associate director of state and local research at the Center for Retirement Research at Boston College, said he worries as plans try to juice up returns by moving money out of public markets and into private investments. "They've actually shifted to a riskier portfolio," he said.

Inflation too is a scourge and historically has been Enemy No. 1 of retirees, though cost-of-living adjustments can make up for some or all of the lost purchasing power, depending on the plan and rate of inflation. But that too means higher costs for public employers.

Still, Aubry cautions against reading too much into one year of bad returns. When you average the losses out with the prior year's gains, funds are chugging along pretty well. "It's hard to say the downturn is any more reflective than the 2021 uptick was," he said.

CalSTRS, for example, says that it's still on track to retire its unfunded liabilities by 2046, the goal of separate 2014 legislation aimed at turning around its finances.

However, if markets were to continue to drift for several years it could boost the political support for public sector defined-contribution plans, which typically match employer contributions with employee contributions but do not guarantee set dollar benefits like California's traditional public pension funds.

The plans, known as 403(b)s, transfer the financial risk from funds and employers to employees if not enough is put away for retirement or if market returns lag. They are promoted by small-government advocates and have been adopted in some states, but there is widespread skepticism about defined-contribution plans given how their private sector 401(k) cousins have not lived up to promises, leaving many Americans unprepared for retirement.

That skepticism may not only be rooted in the plan's performance but also the mood of the public, which has increasingly directed its ire over inequality at Wall Street while younger people consistently poll in support of greater government benefits.

Still, if investment returns are poor for an extended period and public pension funds fall into acute financial distress, all bets are off. And that is not an inconceivable scenario after decades of steady economic growth, low interest rates and expanding global markets.

Scott Chan, deputy chief investment officer of CalSTRS, said the fund takes seriously the scenarios raised by bearish forecasters about the future — such as climate change and growing geopolitical divides.

"Absolutely, there's no time in my career where I've seen so many of these issues and risk stacked up at the same time and converging at the same time," he said.

Jonathan Grabel, chief investment officer of the Los Angeles County Employees Retirement Assn., which saw its fund grow just 0.1% this past fiscal year to $70.4 billion, said there is little doubt that today's investment managers haven't had much experience with such issues.

"The majority of investment experience for people managing money, be it asset management firms or pensions, endowments and foundations, has been with tailwinds in the last 40 years," he said. "I would say now, the environment is that tailwind may become a headwind and is likely more challenging."

This story originally appeared in Los Angeles Times.

Cities’ Retirement Costs to Surge as Pensions Take Market Beating

Jennah Haque
Mon, September 26, 2022 


(Bloomberg) -- Cities will likely have to increase retirement contributions as public pension returns are battered by historically poor financial markets, according to a report released Monday by S&P Global Ratings.

“S&P Global Ratings anticipates that market declines in 2022 and the threat of a recession will likely lead to the need for increased future contributions, in most cases,” analysts led by Stephen Doyle wrote in a report. They said that the positive market returns seen in 2021 have already been, or will be “erased” this year.

Pension funding ratios for the 20 largest US cities increased to a median of 78.5% for the 2021 fiscal year, up from 71.5% the year prior, the report said. The gains are likely to be reversed because of poor market performance, higher personnel costs and rising inflation, S&P said.

Both equity and bond markets have plummeted this year as inflation surges and fears of a global recession mount. The S&P 500 is down more than 23% since January while US investment grade fixed income assets have fallen about 14%, according to Bloomberg’s aggregate index.

S&P warns cities against reducing pension contributions to provide budget relief if funds get tight.

“Increasing pension contribution costs will compete with growing expenditures and potentially tighter operating margins if revenues weaken or decline,” the analysts said, detailing that the company’s “focus” will be evaluating how cities balance budget pressures with ongoing pension reforms.

Out of the 20 cities S&P had surveyed, San Jose, Los Angeles, and Chicago have the highest current pension costs, “though they have budgetary flexibility that we view as strong-to-very strong, which could help incorporate expected increasing annual costs following declining asset returns in 2022,” the analysts said.

Indianapolis, San Francisco and Washington, D.C. have more assets in their pension trusts than liabilities, while Chicago continues to be an “outlier” with the highest current pension costs and net pension liabilities of the surveyed cities.

S&P found that 13 of the surveyed 35 pension plans will need to increase their contributions in order to maintain their current funded ratios.

WORKERS CAPITAL

UK pension funds sell assets and tap employers in rush for cash

Madeleine Bruder

UK pension schemes are dumping stocks and bonds to raise cash and seeking bailouts from their corporate backers as the crisis in the industry continues to rage a week after the government’s “mini” Budget.

Most of the UK’s 5,200 defined benefit schemes use derivatives to hedge against moves in interest rates and inflation, which require cash collateral to be added depending on market moves.

The sharp fall in the price of 30-year government bonds, triggered by last week’s tax cut announcement, led to unprecedented margin calls, or demands for more cash.

To raise the funds, pension funds sold assets — including government bonds, or gilts — causing prices to fall further. The Bank of England stepped in to buy gilts on Wednesday, stabilising the market, but the pension funds are continuing to sell assets to meet cash calls.

“There’s a lot of pain out there, a lot of forced selling,” said Ariel Bezalel, fund manager at Jupiter. “People who are getting margin called are having to sell what they can rather than what they would like to.”

He said the BoE’s intervention had helped to bring down yields in longer-dated bonds but other assets remained “under pressure” because pension schemes were “having to liquidate paper”. He added: “We’re seeing really quality investment grade paper coming up for grabs . . . names like Heathrow, John Lewis, Gatwick, BT — solid fundamentals — to raise cash.”

High-grade corporate bonds denominated in sterling have come under severe selling pressure, with yields soaring 1 percentage point since the UK fiscal package was announced to 6.58 per cent, according to an Ice Data Services index. Yields have jumped 1.63 percentage points this month in the biggest rise on record.

Ross Mitchinson, co-chief executive of UK broker Numis, said: “There has been the forced selling of everything — equities as well as bonds.”

The UK’s domestically focused FTSE 250 has fallen more than 5 per cent this week.

Simeon Willis, partner at XPS Pensions Group, said: “Pension schemes are selling equities and corporate bonds and using those assets to top up their hedges.”

Some managers of the so-called liability-driven investing strategies are demanding more cash to fund the same derivatives position in a dash for safety. The largest managers include Legal and General Investment Management, BlackRock and Insight Investment.

 Hardly a Surprise: Pension Funds Stoked the UK Rout


Analysis by Allison Schrager | Bloomberg
September 30, 2022

The UK’s economic troubles appear to be a story of fiscal recklessness that’s forced the nation’s central bank to step in to stabilize crashing financial markets by buying up government bonds. Are we talking about the UK or Argentina? The real story is actually more complicated. It all comes down to pensions, furthering my pet theory that everything in life comes down to pension accounting.

The market for long-term government debt in the UK has always been a little funky. Their yield curve is normally concave, instead of upward sloping like most countries, because pension funds are big buyers of the debt. British pensions have £1.5 trillion ($1.65 trillion) in assets, and about 20% of the assets are held in direct gilts. As of the first quarter this spring, pensions owned 28% of outstanding UK debt, with an especially heavy presence in the long end of the curve. Private-sector pensions hold just under £100 million in gilts with maturities over 25 years.

Rising interest rates should all be good news for pensions. On paper, pensions have never been in better shape. A pension liability is based on the benefits owed, which is a function of the worker’s salary and years at firm. But pension funds must put a market value on their liabilities for regulatory reasons and to assess their progress meeting their liabilities. Pensions are valued by discounting their future liabilities using the yield curve. The higher interest rates are, the smaller their liabilities. This means that in spite of all the turmoil, pension funding ratios are up. Funds need fewer assets to be fully funded

So what’s the problem? In the last 15 years pension funds turned to Liability Driven Investment (LDI) to manage their risk. This is when pension fund managers calculate the duration of their future obligations (valuing it like it’s a bond) and then hold fixed-income assets that have the same duration. Imagine you owe someone $100 a year for the next 10 years; If you buy a bond that pays out $100 a year for 10 years, you won’t face any risk of not making your payments.

So why all the market turmoil if they were so well-hedged and rates went down? The problem with LDI in the last 15 years was that it was very expensive. When interest rates got very low, that meant two things that are bad for pensions: liabilities got larger; and all those gilts they held as part of LDI earned a low, or even negative return. So pension funds did what everyone does when they want something they can’t afford. They turned to debt.

Pension funds did not go with straight LDI (if they did, they’d be fine today), they did leveraged LDI; they bought bonds and interest-rate derivatives. With the extra leverage, the funds could have 30% of their portfolios in fixed income and the rest in growth assets (like stocks, real estate and private equity) and claim to be fully hedged, explained Dan Mikulskis , a partner at Lane Clarke & Peacock, a London-based consulting firm to major pension and institutional investors. The sales pitch was that you could still get growth without taking any risk. What could go wrong?

But there was risk. If interest rates increased, the pension funds would have to post collateral to maintain their position. And no one anticipated such a large increase in interest rates happening so fast. Pension funds had a buffer to finance rates going up 1.25 percentage points or so, but they were not prepared for what happened this year. The 25-year gilt was 1.52% in January, early this week it was 4.16% up from 3.1% the week before!

Two things went wrong, Mikulskis said: There was already a margin call earlier this year when rates rose, which depleted the pensions’ collateral buffer. But then after Prime Minister Liz Truss’s budget with its tax cuts and energy subsidies came out, adding to the Bank of England’s plan to increase its policy rate, so long-term interest rates spiked 100 basis points and funds had to post more collateral immediately. The logistical challenges of coming up with enough collateral so fast made it impossible. Some funds lost their hedge and the bonds underlying their position were sold, flooding the market with more bonds and pushing rates up further making the problem even worse. That’s why the central bank had to step in.

What does it all mean? The UK has always had a weird long-term debt market because of pensions, and many years of low rates made it even weirder and more fragile. It turns out the British government had much less fiscal space than it realized because of the pensions. But this is not an Argentina situation where reckless spending it the problem, it is the fact that low rates over a long period created a big vulnerability in the pension fund market. (It also doesn’t mean LDI is a risky strategy, unless you lever it up seven-fold.

Some economists are arguing that such a thing can’t happen in the US because rates won’t rise as fast or as much as they did in the UK since America is the world’s reserve currency. Perhaps, but this experience shows why piling on risk and illiquid assets leaves you vulnerable, and very low interest rates for a very long time creates risks many regulators and pension fund managers never anticipated.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Allison Schrager is a Bloomberg Opinion columnist covering economics. A senior fellow at the Manhattan Institute, she is author of “An Economist Walks Into a Brothel: And Other Unexpected Places to Understand Risk.”

More stories like this are available on bloomberg.com/opinion

©2022 Bloomberg L.P.

BlackRock says cutting leverage in some funds

in UK pensions crisis

Carolyn Cohn
Fri, September 30, 2022 

Traders work on the floor of the NYSE in New York

LONDON (Reuters) -U.S. asset management group BlackRock said on Friday it was reducing leverage in so-called liability-driven investment (LDI) funds - which have been at the centre of chaotic market conditions for British pension funds this week.

British government bond prices slumped by their most in decades following finance minister Kwasi Kwarteng's first fiscal statement last Friday, threatening the stability of the country's pension funds and forcing the Bank of England to intervene on Wednesday.

"As a result of the extreme volatility in the gilts market this week, we have been working expediently over recent days to support our clients' interests," a BlackRock spokesperson said in an emailed statement.

"We have been reducing leverage in some of our LDI funds, acting prudently to preserve our clients' capital in extraordinary market conditions. Trading in BlackRock funds has not been halted, nor has BlackRock ceased trading in gilts."

LDI funds can be leveraged up to four times, industry consultants say.

In a note to clients on its LDI liability matching funds, dated Sept. 28 and seen by Reuters, BlackRock said at the time that it would not be proceeding with further recapitalization events until further notice.

It also said in that update that it was "closely monitoring leverage levels across the range" with a focus on those at risk of assets being exhausted.

"For such funds, we will fully unwind exposure to rates and inflation and initially hold the asset in cash before looking to reinstate unleveraged exposure in a controlled manner should future market conditions accommodate," the note added.

(Reporting by Carolyn Cohn, writing by Iain Withers, editing by Elaine Hardcastle and Emelia Sithole-Matarise)