Thursday, June 23, 2016

Opinion: Losses under Goldman, Northern Trust accelerated Teamsters cuts By Elliot Blair Smith Published: Apr 6, 2016 10:38 a.m. ET

Lack of contributions not sole contributor to Central States woes
This is the second of a two-part series on the Central States fund. The first part looked at the organizations that looked out while financial markets wrecked the investment.

One of America’s most battle-hardened pension funds was flying high last decade with large bets on stocks, lower-rated bonds and real estate. But even during the best of times, the Central States Pension Fund needed to draw down at least $1.2 billion a year in capital to pay for overhead and Teamsters union drivers’ benefits.

And when the global financial markets crash struck in 2008, an astonishing $11.8 billion—or 40% of the plan’s total investments—disappeared that year alone. What remained and was recovered afterward couldn’t cover the fund’s long-term obligations.

Today, the Treasury Department is weighing Central States’ application to cut the retirement benefits of two-thirds of the plan’s more than 400,000 American workers, retirees, dependents and survivors who’ve have waited a lifetime for them.

The pain unfolding at the Central States fund is a cautionary tale for all Americans because it underscores the reality that no social safety net is secure.

Also read: How the Teamsters pension disappeared more quickly under Wall Street than the mob

Pension administrators in Rosemont, Illinois, made the benefits-slashing proposal under a law they themselves helped get Congress to pass. Norman Stein, a senior policy advisor at the Pension Rights Center in Washington, says House legislation authorizing the reductions was passed with “no committee vote or debate” in December 2014, as part of a much larger funding bill, and that any Senate amendment “would have resulted in a closure of the federal government.” In a letter to Treasury Secretary Jacob Lew opposing the plan, Stein argues “it is unlikely” the measure “could have survived any open and transparent legislative process.”

More to the point, plan administrators and the government presented the problem almost exclusively in terms of insufficient pension contributions, and not the sometimes-woeful management of the depleted portfolio last decade.

Central States’ investments lost 29.81% in value during 2008 compared to the median loss for all Taft-Hartley Union plans of 20.46%; and a median loss of 26.37% at all Taft-Hartley plans with assets greater than $2 billion, according to data prepared for MarketWatch by Los Angeles-based Wilshire Associates.

And that doesn’t capture the bigger picture.

The pension’s two investment fiduciaries—Goldman Sachs & Co. GS, +3.05%   and Northern Trust Global Advisors NTRS, +3.10%  —each underperformed their benchmark returns in at least three out of four years from 2006 through 2009, while exercising broad discretionary authority as the result of a decades-old consent decree between the fund and the government. Before resigning in July 2010, Goldman underperformed in eight out of the last 14 quarters for which information is publicly available.

So to pay benefits and bills, the pension had to sell more assets each year, accelerating the decline and deepening the inevitable cuts. In 2008, it liquidated investments at a net loss of $2.4 billion, filings with the Labor Department show.

In a statement, Central States’ Executive Director Thomas Nyhan said, “The financial stress that the fund is currently experiencing results from the loss of 13,000 companies due to trucking deregulation, a declining union workforce, growing imbalance of retirees versus active workers, bankruptcy laws which hinder the fund’s ability to collect withdrawal liability assessments, as well as the market turndowns in 2000-2002 and 2008.”

Nyhan said, “It doesn’t make any sense to draw conclusions about the overall performance of the named fiduciaries by looking at the investment returns of one year.” And he pointed out that the $1 billion by which the Central States fund underperformed its self-selected peers in 2008 “was recouped in 2009” when it exceeded its peer median “by roughly $1 billion.” Still, the plan recovered little more than of half of what it lost overall the previous year, and less after the forced sales.

“Even skilled and prudent asset managers incur losses, and no asset manager or process can guarantee gains during every period during every set of market conditions. They were particularly challenging market conditions during 2008,” Goldman Sachs spokesman Andrew Williams said in a statement. He said that Goldman Sachs produced overall positive returns from August 1999 to July 2010.

Northern Trust spokesman Douglas Holt said that a focus on the years 2006-2008 “neglects the fact” that the investments overseen by his firm beat their benchmarks “by greater amounts during the years before and after, in 2005 and 2009.” He also said that “the investment losses of 2008 were fully recovered and are not the primary reason for the plan’s funding gap.”

While Northern Trust did outperform its benchmark in 2009, this did not offset the losses from its underperformance in 2008. Instead, it took more than two years for Northern Trust to recoup its losses, and nearly four years—until 2012—for the fund as a whole to recover all investment losses.

By then, it was too late. The plan’s actuary projected for the first time in 2009 that the fund would become insolvent in little more than a decade. And last year its actuary at the Segal Group certified to the Treasury Department that the Central States fund was “in critical and declining status.”

By then, it was too late. The plan’s actuary projected for the first time in 2009 that the fund would become insolvent in little more than a decade. And last year the actuary, Segal Consulting, certified to the Treasury Department that the Central States fund was “in critical and declining status.”

To be clear, Goldman GS, +3.05%   and Northern Trust NTRS, +3.10%  did not invest the pension’s money directly. Rather, they hired and oversaw the outside managers who did so, serving as an added layer of oversight for the plan along with the non-union administrator, federal regulators at the Department of Labor, and a special independent counsel appointed under a 1982 consent decree to end mob influence at the Teamsters.

Goldman Sachs took over responsibility for $10 billion, or half, of the Central States pension’s assets, in 1999. “Goldman Sachs questions everything. Nothing is assumed. Nothing is status quo. The firm continually strives to do things more efficiently and to improve performance,” Central States CFO Mark Angerame was quoted as saying. Goldman referred to the appointment as “one of the largest fiduciary mandates of its kind.”

Northern Trust came aboard a few years later.

Call it bad timing but “when the stock market crashed in 2000, the Central States pension fund had big bets on technology and telecommunication stocks, energy trading companies and foreign stocks. Some of these stocks became nearly worthless,” The New York Times reporter Mary Williams Walsh wrote in 2004.

“Many rank-and-file Teamsters,” Walsh added, “complain that their questions about the pension fund have been met with bromides about unforeseeable market forces, and about an unusual convergence of stock market losses and low interest rates that is always described as ‘the perfect storm.’ ”

Central States Executive Director Nyhan chastised Walsh and the Times for, among other things, reporting on a questionable Russian investment. In a two-page rebuttal, he argued that the “total loss was $9.” Similarly, when I wondered why the pension bought a $250,000 Iraq bond while the U.S. government was fighting a war there, Nyhan replied “the discussion of the Iraq note is sensationalism at best.”

Nyhan told me that “based on many of your questions, it appears you do not fully comprehend the issues and have pre-conceived notions. In addition, you have taken a portfolio comprised of thousands of securities and selected a few underperformers to suit your apparent view.”

To its credit, the Central States fund outperformed the top tier of its self-selected peers in the three-year period through the first half of 2007.

Yet facing pressure even then to improve plan finances or see the fund collapse, about two-thirds of the portfolio was in stocks, according to the special independent counsel’s quarterly reports filed in federal court in Chicago.

This was an aggressive bet compared to most Taft-Hartley union pensions whose median portfolio consisted of less than half equities, according to data prepared for me by the Wilshire Trust Universe Comparison Service

The fund also owned about $1.4 billion in bonds rated below single-A—a 141 percent increase in the lower-grade debt over just three years—and at least $270 million in mortgage bonds issued by Bear Stearns, Countrywide Financial, IndyMac Bank, Lehman Brothers, Washington Mutual—and dozens of other fated real estate lenders and bundlers—according to filings with the Labor Department.

Since these troubled securities overlapped with the pension’s holdings of the same companies’ stocks, it meant even greater concentrations of leveraged assets.

Nyhan initially denied my request for more detailed information on the pension’s real estate portfolio, stating that the fund had “no physical real estate assets” and was only 1.6% invested in real-estate investment trusts at the end of 2007. He added that the fund’s records “do not segregate mortgage-backed securities from other fixed income, but a review of our holdings does not indicate a concentration of these types of securities.

Later, Nyhan provided more information. Subprime mortgage securities were a small component of Central States’ portfolio but they nearly doubled to $45 million under Northern Trust in the market collapse year of 2008 even as subprime assets under Goldman’s oversight fell to $29.2 million from $112.9 million.

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Bear Stearns stocks and bonds were in the Central States portfolio.
Without Nyhan’s assistance, I scanned dozens of pages of securities listings in the fund’s annual reports, finding that as of December 2007 Central States held:

• 39 Bear Stearns bonds—32 of them already carried at a loss—and 46,500 shares of Bear Stearns stock that also were under water;

• 47 Countrywide Financial bonds, all but three of which had dipped into loss territory, and 496,225 Countrywide shares written down 60% in value;

• 25 Lehman Brothers bonds, 19 of them valued below cost, and 312,525 shares of Lehman stock held at a slight gain nine months before its bankruptcy;

• 33 Washington Mutual bonds, 27 of them valued at less than cost, and 654,225 shares of Washington Mutual stock carried at a 56% loss nine months before it became the largest bank failure in U.S. history.

• A $19.5 million investment in the Olympus Real Estate Fund L.P. marked down by 97%, on its way to being valued as worthless, and a $4.6 million stake in the Starwood Opportunity Fund IV L.P. written down by 78%.

And that was before the reckoning next year, when Goldman Sachs reported a 42% loss on real estate investments for the fund in just the fourth quarter of 2008, and Northern Trust recorded a 34.28% loss on real estate.

By comparison, Taft-Hartley Union plans as a whole absorbed a 9.28% quarterly loss on real estate, and large plans — like Central States — with more than $2 billion under management reported 10.71% declines, according to Wilshire.

“This fund knew it was in long-term trouble,” says Terrence Deneen, a retired executive at the government’s Pension Benefit Guaranty Corporation in Washington. Until 2010, he worked with union-oriented pension plans such as Central States.

Under an agreement with the Internal Revenue Service to defer a statutory funding-deficiency notice, Central States also began imposing—and collecting—higher pension contributions from employers in 2007.

That December, the fund received a $6.1 billion lump-sum payment from one of its biggest employer participants, the United Parcel Service, arising from a negotiated agreement that allowed the Atlanta-based package handling company to cease making contributions. It was the worst possible moment to get the money.

The greatest financial crisis since the Depression was getting under way.

Central States told me there “was no separate accounting” for the UPS fund, and could not specify how much of the payment might have been lost. But two of the special independent counsel’s court reports—filed 10 months apart—outline investment allocations, and percentage investment returns, for the UPS payment.

From these disclosures, I estimate that $1.8 billion, or 30%, of the $6.1 billion to support union drivers’ future retirements evaporated in 12 months.

Moreover, because the UPS obligation “was calculated near the peak of the market, it did not capture the growth in the unfunded liability that occurred with the onset of the financial crisis,” according to Alicia Munnell, director of the Center for Retirement Research at Boston College.

Goldman resigned as a fiduciary in mid-2010 under what Nyhan describes as “a mutual decision” with “no acrimony between the parties.” Central States and Goldman Sachs declined to provide me with a copy of the resignation letter.

Increasing fees
Goldman Sachs and Northern Trust each had charged increasing sums for their work in four previous years, peaking in the abysmal 2008, and then declining after Goldman’s share of the portfolio lost 36.99% in value (and another 8.32% in the first quarter of 2009); and after Northern Trust saw a 38.02% annual loss (followed by a 7.71% first-quarter decline). Goldman spokesman Williams said the firm’s fees peaked at $6.5 million in the pension’s worst year because it invoiced Central States five times in 2008, after billing it only three times in 2007.

All told, Central States paid Goldman $25.2 million from 2005 through 2009, and Northern Trust $16 million, according to annual filings with the government.

Williams also said that the Goldman and Northern Trust performances look worse than they should because they had to make outsize investments in stocks—hit particularly hard in 2008—to meet the fund’s overall target allocations. After 2007, the two firms actively managed only 60% of the fund’s assets. The balance was held in passive stock and bond accounts that also suffered losses.

With Goldman’s departure, the $5.4 billion that remained under its control was transferred to Northern Trust. And the pension’s overall investment-management fees fell—not solely due to the now-depleted size of the fund.

Pension staff attributed an 18.5% decline in investment-management fees in the first quarter of 2011—for a savings of $2.9 million—“to the fund’s reversion to the single named fiduciary model as well as an increased allocation to indexed investment accounts, as opposed to accounts under active management by compensated investment managers,” the special independent counsel reported.

Overall, Central States recorded a 7.1% average return for the decade through December 2014, narrowly outperforming the 6.9% median return of its peers. The plan underperformed again last year, recording a -0.81% decline against its 1.38% benchmark, the special independent counsel reported this month.

That brought the fund’s operating deficit from 2005 through 2015—including investment returns, benefits payments and overhead—to $13.6 billion.

The proposed benefit reductions Treasury is reviewing will average only 22%, according to the special independent counsel. And that seems modest given that, in percentage terms, the unfunded liability is more than twice as large. But some pensioners who are just reaching retirement age will see their benefits halved.

Nyhan told me the “rescue plan” of slashing pensioners’ benefits is “a gut wrenching exercise” and “an emotional issue for our participants.” And he said “we challenge anybody opposed to the rescue plan to put forth a viable alternative.”

My view is that passing the buck—especially somebody else’s—is not the complete solution. Central States’ investment record merits scrutiny, as well.

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