Wednesday, January 20, 2016

Kentucky Fried Pensions by Chris Tobe (Book Review #2 of 2016)


Kentucky Fried Pensions: Worse Than Detroit Edition

This book is the most important work of non-fiction that has never been edited. The horrible quality is why some don't take Tobe seriously, even though he is a CFA with a long record as a pension consultant. It is like reading a pre-release draft. There are paragraphs that are copied and pasted again in various locations and very little logical flow. There are misspellings, grammar mistakes, font changes, etc. Tobe claims his son worked on the book with him, I guess that makes him the editor; that is just sad-- is there not a serious publisher who would take on this work?

That this book has few reviews either on Amazon or Goodreads is disturbing. This book spells out the pension disaster that is the Kentucky Employees' Retirement System, of which few people outside of KY are even aware. Matt Taibbi with Rolling Stone and some other journalists have cited the work, but few others-- even locally. Tobe signed books in 2014 at my local library but it didn't even bother to shelve a copy.

At 17 percent (as of late 2015, probably worse now), Kentucky may have the worst-funded pension system in the U.S. and be the first to be unable to pay current obligations. Even if the KY General Assembly makes the actuarial required contributions (ARC) in the next few years, it will still face a cash-only position in a short time; it needs more than ARC. No one knows what will happen once it reaches that point. I write this about a week before newly-elected Governor Matt Bevin submits his first biennium budget, hopefully with a full-fledged plan toward funding the pensions and supporting efforts toward transparency.

This book explains how KERS got that way, how it is dragging the Counties' and Kentucky Teachers' pensions down with it, and what happened when people like Tobe tried to shine a light as disinfectant. It is a story of greed, corruption, stupidity, and complicity (complicity in that hundreds of thousands who rely on the KERS pension have never actually read what this book says or know how unlikely it is they will ever see the benefit they were promised).

In 2008, Tobe became the first person with investment experience or financial certification ever to serve on the investments committee of KERS. He was secretly voted out in 2009 when he started poking around, only to be reinstated by legislative mandate in 2010. He witnessed ad vocally opposed KERS' hiring of a currency manager with no large-scale investment experience and a non-sensical strategy (which lost the system $125 million) and a start-up hedge fund, both under shady pretenses, without consulting the independent investment consultants that KERS pays for, and with large payouts to placement agents. The use of placement agents and their cost to the system are what Tobe is the most angry about. Crit Luallen, the State Auditor, defended KERS' use of placement agents even while other retirement systems have been banning their use. Key members of the Board were given vacations and trips to England all while retirees' money was being poorly invested in an untransparent manner.

"The KRS culture has even corrupted something as basic as custodial services. The lack of competitive bidding through RFP's is a major cause. KRS has investment policies in place to prevent corruption, but they break them whenever they want. I pointed out a number of investment policy violations...but they have been totally ignored by KRS--enabled by an auditor and attorney general who refuse to enforce them" (p. 99).

Whenever competent people, such as future State Budget Director Jane Driskell, get elected to board positions where they can ask questions, KRS cites or stretches rules to send them packing. Where there are rules, or even laws, limiting the terms of board members, KRS finds a way to keep them on.

For example, a law preventing KERS board members to run for a fourth or fifth turn was nullified by an opinion by Attorney General Jack Conway in 2009. Those board members were friendly with a particular hedge fund, which also employed a Conway campaign advisor (he was running for Senate against Rand Paul). Two months after the AG's decision, $100,000 from a Wall Street fundraiser featuring various pension fund vendors was deposited in his campaign fund (p. 111). Tobe expresses his frustration at informing the Attorney General of various violations only to be ignored or rebuffed. Draw your own conclusions. 

Judging from statements made about Detroit's ailing retirement system, and Puerto Rico's bond default, Republicans controlling Congress are vocally unwilling to bail out states, territories, or localities. (Detroit's pension was a problem not because it hadn't been fully funded, unlike Kentucky, but because the city could no longer afford to make the full ARC.) Future Governor Bevin (misspelled "Beavin") only makes a cameo in the book as Sen. Mitch McConnell's more conservative Senate primary opponent who would seemingly put pressure on McConnell not to bail out the KERS.

The Kentucky Teachers are in better shape, but have also suffered from the chronic underfunding as the Kentucky legislature found away against its constitutional requirement to pass a balanced budget by borrowing from its pension. But KTRS has not made the same unwise investment decisions or hired as many shady characters. "If KRS had allowed their neighbours at KTRS to manage its portfolio, the system would have been more than $420 million richer in the 2013 fiscal year alone....KTRS uses low-cost index funds while KRS sends $50 millio in fees from no-bid contracts to its Wall Street hedge fund and private equity pals."

The actuarially assumed 7.75% rate of return seems fantasy. Even when the fund sees high returns and the General Assembly makes the full ARC (as in 2014) it goes backwards because the drain on its assets from the increasing number of retirees is so great. I'm told the assets are being sold at firesale prices in order to have enough cash on hand. Now that the current Governor has put a hiring freeze in place, there are few new hires to pay into the system to counter the recent increase in retirees with the exit of the previous Governor's administration. I'm sure the next analysis will show it further on the brink and risk further downgrades of Kentucky's debt, especially as legislators are still floating the idea of issuing bonds to make ARC payments. Anything under 80% funded is considered a "death spiral," and Kentucky is well past that. What happens next?

Tobe offers a couple solutions, both of which are unlikely. The first would be for a court to rule that the pension must adhere to the same laws as private pensions, which would bring much more transparency and discipline. Even then, Kentucky would still have to pony up the money for the full ARC. The other solution is just to pay the full ARC for the next 30 years. This would require $1 billion in additional contributions each year and likely $1 billion in tax increases to fund it. Add a slighly less amount for the Kentucky Teachers and you have Kentucky's current fiscal picture.

In a week's time, the newly elected Republican Governor will drop his budget likely filled with dramatic austerity measures into the General Assembly. Given the debts incurred by decades of mismanagement, this should not surprise anyone, but it will because very few people have read this book. There is vague outrage, but few pitchforks in Frankfort demanding change at KRS. The KY Senate just passed a bill that would bring greater transparency to the system, but it stands little chance of passage in the House. People are afraid of the light. As illustrated in the book on Kentucky feuds that I reviewed just prior to this one, evil prevails when the majority stays silent.

3 stars due to the unedited quality.

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