The Reckoning in Pension Funds Draws Closer

The outlook for pension systems is growing increasingly dire. Promises made to retirees have been generous and they can only be kept if prices for all kinds of assets move consistently higher.

The trouble is that the past three years don’t look like the first twenty years of the century.

The 40-year bull market in bonds ended. Commercial real estate is in deep trouble. And there are many indications that a recession is coming, which should translate to lower stock prices.

Now some large pension programs are looking to borrow money to meet their obligations. The union-boss-controlled California State Teachers’ Retirement System (CalSTRS) announced plans to borrow $30 billion in an effort to avoid selling distressed real estate and bonds.

They don’t have much choice. Cutting retirement benefits is forbidden by law.

For some systems in certain locales, such as the government employee pensions in Illinois, changing the law means amending the state’s constitution -- a political impossibility.

The CalSTRS move to borrow roughly 10% of its total asset value smells of desperation. It is a gamble which pays off if there is a big recovery in commercial real estate and bond prices.

The outlook for commercial real estate remains gloomy. The retail sector has struggled for years due to the ongoing transition from brick and mortar to online shopping.

More recently demand for office space has been in decline. Work from home was a trend prior to COVID, and it massively accelerated during the pandemic.

The most likely scenario for a recovery in bond prices involves a decline in stock prices.

The Fed isn’t likely to start dropping interest rates until stock market weakness signals recession or even worse economic malaise.

If markets fall, it will only get harder and more expensive for pensions to borrow next time.

The alternatives to borrowing will be a fire sale of assets, or a bailout from either the state or federal government.

Given that California is facing a record $68 billion deficit and federal deficits are also skyrocketing, bailouts could be a difficult sell. Liberal California state politicians will likely want to rescue pensions, but they will have to borrow to do it. The state’s creditworthiness could be an issue.

At the federal level, a bailout to maintain lavish retirement benefits for teachers in California is going to be a hard sell among representatives from more conservative states.

Overextended pension systems managed to stay afloat when prices for equity, real estate and bonds all moved higher. The promises made to retirees assumed a mostly uninterrupted bull market in financial assets.

Few state pension systems allocate any of their assets to physical precious metals in order to protect retirees from inflation and credit risk. One notable exception is the Ohio Police and Firefighters Pension Fund which reportedly acquired a physical gold holding.

Now pension systems that are hitched entirely to financial assets must navigate potential bear markets and tighter borrowing conditions. Many of them may not succeed.

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