Pensions In Peril: Can You Afford to Retire?

Ongoing testimony before the Committee On Oversight and Government Reform has given new insight to the “blame game,” as leaders from corporate America and governmental agencies point fingers at everyone and everything for the cause of the financial mess gripping the nation. Even the revered Alan Greenspan defended his own inactions before the Committee recently, which included allowing Wall Street firms to run amok as they traded in the complex market of credit-default swaps with minimal regulatory oversight during his tenure as chairman of the U.S. Federal Reserve.

Following Greenspan's performance last week was Christopher Cox, chairman of the Securities and Exchange Commission (SEC). Like Greenspan, Cox expressed “surprise” and “shock” regarding the financial events of the past two months. Mind you, these events occurred under the supposed watchful eyes of the SEC - the very same firm that also has taken great pride in keeping its distance and so-called independence from the Wall Street companies it was charged to oversee.

The mock surprise of regulatory leaders may well be the final straw for investors. Quite simply, they are fed up with the culprits crying victim. Now, across the country, the next stage of the financial crisis may be coming to fruition: pension funds.

In the past six months, a combination of subprime fallout, the upheaval on Wall Street and the credit crisis has forced pension fund managers to face a grim reality: losses in the billions of dollars. Since January, exposure to subprime investments has caused many state and municipal pension funds to report losses of at least 30% or more, with the future outlook for more losses almost certain.

The California State Teachers Retirement System, the largest public pension fund in the United States, reported its assets had declined by more than 20% through Oct. 10. In Virginia, the state worker pension fund there declined 20% in value since July, or about $11 billion. New York's Common Retirement Fund, which pays pension benefits to retired state-and local-government workers, shrunk by about $30 billion between April and September - about a 20% drop in the value. The Teacher Retirement Fund in New York, which pays benefits to teachers and school administrators outside New York City, saw the value of its fund's investments fall by $7 billion, from $95 billion in July to $88 billion at the end of September.

Despite record losses, many pension fund managers continue to reassure retirees and current employees that their funds are safe and the assets sufficient to pay benefits for several years.

In reality, that may or may not be the case, depending on the quality, quantity and valuation model used to determine the actual value of the assets held in the pension fund.

Valuation Models Questioned

Specifically, many of the portfolios of large pension funds include a high concentration of hard-to-value and difficult-to-sell assets, including mortgage-related securities and other collateralized pools of debt. These investments do not readily trade on the secondary market. As a result, the value assigned to them often does not reflect their true value.

The Financial Accounting Standards Board rule, known as FASB 157, has three classification levels that are used to determine the underlying value of a company's financial assets. They are:

• Level 1 assets: These assets have readily observable prices and trade in active markets. An example is a share trading on the New York Stock Exchange.
• Level 2 assets: These holdings do not trade actively or have easily obtainable prices, but they are made up of components that do have solid pricing information. An example is an interest-rate swap. Values are based on “observable inputs,” or prices of similar assets traded in the market.
• Level 3 assets: These holdings (including collateralized debt obligations, collateralized mortgage obligations, subprime-mortgage derivatives and other securities) are illiquid and for which market prices are so scarce that companies use internal models to gauge their value. Estimating the value of these assets is subjective and relies on assumptions and theoretical opinions by management.

Because of the subjective nature of Level 3 asset valuation, it is often referred to as mark-to-myth, mark-to-imagination, mark-to-fantasy or mark-to-make believe.

In the current economic environment, Level 3 assets in portfolios of large institutional investors - such as corporate and state pension funds - are increasing because these instruments simply are not trading. For investors in such pensions, that spells trouble in the form of financial loss.

First it was the Wall Street investment firms, which marketed and sold good-as-cash investments like auction-rate securities. That turned out to be a lie.

Next, banks and subprime lenders decided to lend money to people who had no business getting into homeownership with the lure of exotic loans with cheap interest rates that skyrocketed after certain period of time. That turned out to be a lie.

Then the regulatory agencies - the government watchdogs of Wall Street - contend that all along they were policing the market, ensuring the best interests of investors remained intact. That, too, turned out to be a lie.

Now, America's public and state pension funds are facing potential devastation from plunging asset values due to opaque accounting rules and lack of transparency.

Meanwhile, everyone from Wall Street CEOs to the subprime lenders seems to be getting a free pass for their misdeeds with billions of dollars in government-backed financial bailouts. Is it any wonder Joe the Investor has had enough?

Our affiliation of securities lawyers is actively involved in advising individual and institutional investors in evaluating their legal options when confronted with subprime and other mortgage-related investment losses.

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