After years of channeling money into in mortgage backed securities and collateralized debt obligations portfolios of mortgages bundled and sold as debt securities the total size of pension fund securitizations are massive. Thomas Martin, president of the Homeowners Consumer Center estimates pension funds will take a 1 trillion dollar hit from devalued securities.
The nation’s largest public pension fund - the California Public Employees Retirement System (CalPers) - could take a hit as large as their $2 Billion dollar residential mortgage portfolio.
WARY EYES MONITORING WALL STREET, School Officials Assess Risks Posed by Turmoil
by Linda Jacobson | EdWeek
Published Online: Sept 18, 2008 | Updated: Sept 23, 2008
School business officials kept a close watch on the 
financial markets this week—and on district investment portfolios and teacher-retirement funds—as stock prices gyrated and once-sound institutions got government bailouts or crumbled into bankruptcy.
While financial observers said it was too soon to predict how Wall Street's upheaval might affect school districts, they generally offered reassurance, even as the federal government late last week rolled out a plan to rescue banks from billions of dollars in bad debt. Several experts said that state-backed employee-pension funds—and even supplementary retirement accounts such as those offered by the troubled American International Group Inc.—should be secure.
More murky, however, is the impact of the financial crisis on districts’ own investments and the effect any further tightening of the credit market might have on their ability to get affordable financing for capital projects.
School systems are hardly insulated from broader market troubles: In Florida late last year, several school districts, cities, and other government agencies were forced to pull their money out of a state-run investment pool after certain holdings were downgraded by bond rating agencies.
Trader Tom Kalikas, center, works on the floor of the New York Stock Exchange on Sept. 17, a day on which stock prices plummeted. —Photograph by Richard Drew/AP
Before turning to a New York City-based asset manager to help repair the damage, the state of Florida temporarily closed that fund, leaving some districts without a way to pay their employees. ("Fla. Fund’s Woes Spark Investment Jitters," Dec. 12, 2007.)
“These are all long-range problems,” Ronald Snell, the director of the state-services division at the National Conference of State Legislatures said of worries stemming from Wall Street’s troubles. “We don’t know yet where this is going to go. It could mean a sustained period of lower investment values.”
The most immediate impact, finance experts said, would be felt by any district that might have investments tied up with New York City-based Lehman Brothers Holdings Inc., the famed investment bank that filed for bankruptcy last week.
“While the great majority of school districts are very conservative with investments, the sheer number of districts across the country means it would not be surprising if a few had ventured into risky territory and now are regretting it,” said Bob Ward, the director of fiscal studies at the Nelson A. Rockefeller Institute of Government in Albany, N.Y.
Scott Pattison, the executive director of the National Association of State Budget Officers, based in Washington, said that because investments for the public sector are so diversified, the failure of one or two financial institutions should not have serious consequences.
‘A Lot of Nervousness’
Market turmoil also may raise concern among school system employees about state pension funds for teachers.
But Mr. Snell of the Denver-based NCSL said that while such funds might lose some money, school retirees would not be directly affected because states have to contribute to those accounts, which guarantee a certain defined payout for retirees.
Nationally, public-employee pension systems covering educators, including K-12 and university employees, had assets totaling $2.37 trillion in their trust funds as of January, according to the National Council on Teacher Retirement.
“Those pension benefits are as solidly guaranteed as anything can be,” Mr. Snell said.
A greater source of anxiety for many teachers may have been the fate of AIG, a huge insurance and financial-services company that is a major provider of 403(b) retirement accounts. The company was forced to the brink of failure by problems stemming from collapse of the subprime-mortgage market, and was saved last week by the Federal Reserve, which is providing an $85 billion emergency-loan package.
“There is a lot of nervousness,” said Dan Otter, a former elementary and middle school teacher who operates a Web site that gives advice to teachers on saving for retirement. ("Unions’ Deals With Brokers Raise Issues," June 7, 2006.)
A 403(b) account, similar to a 401(k) in the corporate sector, is a voluntary retirement-savings program offered by districts and other nonprofit organizations to their employees.
A “talking points” memo from AIG, posted on Mr. Otter’s site, indicated that the company’s problems won’t affect district employees who have annuity products from AIG because those policies are underwritten by the Variable Annuity Life Insurance Co., or VALIC, which the memo described as a “strong insurance company.”
“Although AIG faces short-term liquidity pressures,” the memo says, “the company differs from other financial institutions that have been under pressure in that AIG has strong, well-positioned businesses in diverse markets around the world and a deep asset base.”
But given the doomsday tone of much of the news coverage, many employees are nervous, said Mark Pepera, the chief financial officer of the Westlake, Ohio, city schools. About 70 percent of the district’s 630 employees participate in 403(b) plans, he said. One of the district’s providers is AIG VALIC, an AIG affiliate.
“The headlines are creating somewhat of a panic among employees,” Mr. Pepera said. “But it doesn’t seem that the company’s financial woes will affect them.”
The Los Angeles Unified School District uses AIG as one of its providers for a 457 plan, which is similar to a 401(k) or a 403(b), but doesn’t include a penalty for making an early withdrawal. Gregory Kildare, the chief risk officer for the roughly 700,000-student district, said that AIG acts simply like a brokerage company, and that the employees actually have their assets invested in other companies.
"At this point, I'm not concerned about [AIG] insurance products," he said.
Opportunities and Risks
With many states already trying to close budget deficits, the tumult in the financial world couldn’t come at a worse time.
Still, the outlook was not all bad. Mr. Snell noted, for example, that if the Federal Reserve were to cut interest rates, that could prove “a good time for the public sector to be borrowing.”
The credit crisis can cut several ways, however.
For example, school districts sometimes purchase bond insurance to improve their credit ratings. The insurers can sometimes be linked to riskier investments and be downgraded by bond-and credit-rating agencies. That could lead districts to steer clear of buying such insurance and even to raise property-tax rates in order to get a higher bond rating on their own.
One of the possible bright spots in the current economy might be declines in oil prices, which could help districts that have been struggling with transportation-fuel and utility costs. ("Increasing Fuel Costs Hit Hard," July 16, 2008.)
The price of a barrel of crude oil fluctuated last week, falling to less than $100 at some points. But Mr. Snell suggested relief in that area is likely to be temporary. “In the long run, energy prices are going to rise,” he said.
Thomas White, the executive director of Michigan School Business Officials, based in Lansing, sees the current crisis as an opportunity for learning.
“Everybody is looking to maximize their investments, and making sure their investments are secure,” he said. “It’s just a matter of being cautious and asking questions.”
The Associated Press contributed to this article.
TIME TO SELL OFF REAL ESTATE ASSETS?
Lauren Beale writes the L.A, Land/LA Times real estate blog
A fire sale of sorts for commercial real estate is imminent. At least that's the take at Newport Beach-based AppraiserValues.com's Cap Rate News Blog. In the wake of the Wall Street meltdown, "liquidation of real estate assets will be one of the first places firms will look for cash."
If you think this doesn't matter, you must not be a teacher who hopes to retire one day. Writes Warren K. Hoppke, senior real property analyst and a member of the Appraisal Institute: "The nation's largest public pension fund, the California Public Employees Retirement System (CalPers), could take a hit as large as their $2 billion dollar residential mortgage portfolio."
Hoppke sees a "long flat period of very weak demand for real estate" that could last for the next decade. In the short term, "expect to see commercial real estate price declines throughout 2009 and 2010."
THE SELL OFF OF COMMERCIAL REAL ESTATE BEGINS
Cap Rate News By Warren K. Hoppke, SRPA
Senior Real Property Analyst
Member Appraisal Institute
September 21st, 2008 11:05 AM -- As Wall Street reels from major losses many cash starved Wall Street firms, financial institutions, and some insurance companies are scrambling for capital to shore up struggling balance sheets. Liquidation of real estate assets will be one of the first places firms will look for cash. 
Prices are on the decline and many firms will soon be in the market hocking their commercial real estate in trade for cash. To top it off, unemployment has doubled over the past year and continues its upward spiral. This double whammy will result in investors placing upward pressure on capitalization rates as vulture funds hover around looking for fire sales on commercial real estate. Unfortunately, one feeds on the other and as Wall Street layoffs start commercial office and industrial markets will be hit.
For example GE has been selling off its commercial real estate and many 
other cash strapped corporations and financial institutions will follow. Credit has contracted by almost 400 billion dollars. As credit contracts it has a multiplier effect. The multiplier effect can be 3 to 4 times the amount of the contraction. As Leman Bros. goes under approximately $150 billion of bonds will default.
As reported by AFX News Limited, besides banks and other financial institutions pension funds have been among the top investors in mortgage backed securities (MBS) and collateralized debt obligations (CDO). After years of channeling money into MBS and CDO portfolios of mortgages bundled and sold as debt securities the total size of pension fund securitizations are massive. Thomas Martin, president of the Homeowners Consumer Center estimates pension funds will take a 1 trillion dollar hit from devalued securities.
The nations largest public pension fund the California Public Employees Retirement System (CalPers) could take a hit as large as their $2 Billion dollar residential mortgage portfolio.
Has the Great World Wide Depression started ? The first phase started in the residential market from the bottom up as prices rose faster than incomes could support creating a drop in demand. As demand dropped off due to affordability issues builders were in denial and continued to build because their astute real estate advisors said demand was stronger than ever because of new household formations and high population growth. After their buyers got into a home they quickly found out they could not afford to make the fully amortized payment. As a result, builders started to realize that affordability was the dominate player in the demand for residential real estate and not just new household formations and population growth.
Technically, prices should deflate until they reach equilibrium in line with median income levels. Since markets tend to overcorrect either on the upside or the downside the real estate market will most likely overcorrect before it comes back to equilibrium. With the entrance of a government mortgage bailout a monkey wrench will be throw into the mix. The markets will now stabilize at higher levels than equilibrium thus creating a long flat period of very weak demand for real estate. This could last for the next decade until incomes catch up with pric
es and consumers have a chance to save for down payments.
The 2nd phase is the unemployment created by the down turn in real estate. The recession that started in the 1990’s started with a rise in unemployment creating a drop in demand for housing which then infected commercial real estate. Now,with Wall Street and financial firms collapsing and major corporations starting to layoff, the 2nd phase has started. This is the double whammy that we did not have in the 1990’s and that’s why this will be many times worse the 1990 downturn.
As employment unwinds it will set the stage for another round of price declines. As people lose there jobs they will not be able to make their house payments which will force more and more people into foreclosure. This will create additional downward pressure in the housing market. Additionally, the retail, office, and industrial markets will experience a drop in demand as businesses cut back. This will result in increasing vacancy levels and declining rents as layoffs and faltering businesses continue the downward cycle.
Expect to see commercial real estate price declines throughout 2009 and 2010 as cap rates rise due to increasing vacancies, declining rents, and increasing investor risk premiums. We should never forget there are business cycles and real estate is by its very nature cyclical.
Again, to answer the question will cap rates increase one need only look at the equation …………….. Cap Rate = Risk free Rate + Risk Premium + Capital expenditures - minus expected appreciation. We now have two of the four variables on the rise.
Posted by Warren Hoppke, SRPA ( Principal ) on September 21st, 2008 11:05 AM
very informative. I expect a lot more to unfold in the coming months. 2009 will be a tough year for sellers of commercial property assets.
ReplyDeleteThanks,
Alan Bernier, Rofo - San Francisco Office Space