Tuesday, March 13, 2007

Taxpayers should be afraid, really afraid Taxpayers should be afraid, really afraid

Economist.com: Yes, they can go down too points out that some of the subprime mortgage market is being funded by state and local pension plans trying to recoup losses.
It's a pretty common story: investors with big losses behave essentially like gamblers in a casino, trying to double down in order to recover their previous position. In this case, state and local pensions have enormous unfunded liabilities. This is due in part to unrealistic valuations of their asset base during the stock market bubble, which left them with an enormous hole when the bubble collapsed. It is also due to the massively overgenerous promises politicians made, in part because the bubble inflated tax revenues to unrealistic levels in many localities, and in part because until recently they didn't have to account for their pension liabilities the way private companies do, which made big boosts for public sector pensions feel like a freebie for their supporters in the civil service unions.

So now you have these pension funds pouring into risky instruments that promise higher potential returns in order to close up the holes. Instruments that, from the quotation, they don't understand too well, or keep track of too closely. It's not entirely clear that this fellow grasped the fact that the reason the CDO's offered such attractive returns was that they were extremely risky, potentially leaving him with nothing at all.

Pension funds are meant to cover one of the most predictible risks of all: the risk of growing old. I find it hard to believe that responsible fund managers could be pouring much cash into the riskier tranches of credit derivatives...

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