Underwater Public Pension Funds

As Ben Bernanke and the Financial Times opine about the end of the recession and the miraculous recovery of financial firms after Lehman's collapse a year ago, spare a thought for one of the hardest hit sectors. Many public pension funds, those owned and managed by individual states (US) or federal governments (US and UK), are in mortal danger of collapsing. I am writing an article about the trend toward liability driven investment (LDI) in pension funds, where funds use interest rate futures and swaps to help manage their long-term risk. If people live 20 or more years after they retire, which is increasingly the case, the surplus risk to the underlying assets can be mitigated. Most pension funds do not employ this method, preferring instead the 'wait and hope' method of investing (which, as we have seen, worked pretty badly last year). A portfolio manager tells me that the worst problems are currently with the public pension funds, and that they are "horribly underfunded". Because we taxpayers fund the public pensions there is little incentive for public officials to tell us how bad the situation really is. We might just vote them out, and vote to stop giving state and federal workers pensions based on their final salaries. The MA state fund lost almost a quarter of its value in the year ended June 30th. California's CalPERS is so underwater that, rumor has it, the government is looking to see if there are legal ways to stop existing pensioners from getting the full amount agreed. (My source tells me that there are retired town managers in CA making $400k per year in benefits.) Until this mess is sorted out I find it hard to believe that the financial markets have truly recovered. This might just test their resilience.