Monday, August 13, 2012

The Coming Recession and Will CalPERS Take a Hit?

Recessions happen pretty regularly every 4.2 years so we are about due for one - it is 4 years since the 2008 decline.  This could be a tipping point for many cities and states trying to pay pensions, etc. as they see tax revenue decline further.  As Buffet said, "you don't know who's swimming naked until the tide goes out."  A likely cause fo the next recession is a Euro break-up.

Arguing that the wisest course for the weaker Euro-zone countries is to leave the Euro: 
The significance of this article is that it appears in the very serious "Financial Times" of London and that it is written by an American adviser on the President’s Council on International Activities.  In agreement in greater detail is "The Economist" for this week: and

This affects pensions because ING (a large Dutch bank) estimated that a breakup of the Euro would result in a decline in GDP of Euro-zone members of about 8% the first year and about 4% the second year.  The US GDP's decline was estimated at about 4% the first year and about 2% the second year.  For comparison, the US GDP declined about 4% in the 2008 recession 4 years ago.  A similar decline in GDP with a concomitant decline in tax revenue this time around would likely put a lot of US states, counties, and cities over the edge into bankruptcy, now that that wall has been breached. 

The numbers for GDP decline are falsely precise.  No one really knows what would happen, but there is general agreement by all who have looked at it that it won't be pretty.  Eventually, there will be a strong bounce back but it could be years for that to happen.  For example, Greece would overnight become 50% cheaper as a vacation destination but it would be saddled with crushing debts denominated in Euros.  It won't be able to pay them and a default - whole or partial - will bring down big banks and investors (like pension funds) who will see a substantial portion of their assets disappear in a poof of drachmas.  Greece won't benefit because without loans it will have to lay off over 100,000 govt employees who were hired simply as payback for bringing in votes (25 votes got you a govt. job). further depressing the Greek economy.

In separate news, CalPERS is at risk of not being paid by their debt by cities in bankruptcy if the municipal bond insurer's win their suit against Stockton.  The bond insurers are saying that (simplifying here) if they have to take a hit, so should CalPERS, especially since one of the bonds Stockton wants to default on was to pay off the unfunded liability arising from CalPERS inability to make the 7.5% they assume.  When CalPERS doesn't make their 7.5% return on investment, that becomes an "unfunded liability" that the state, cities, and counties have to make up.

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