Archive for June, 2010

He claimed that he is in his recent article posted in Citywatch.

I’m sure Council Member Zine is aware of the serious implications unfunded pension liabilities will have on the city’s finances.

If he is as focused as he claims, he did not offer any indication of it.  If anything, he did a little tap dance pointing to the sanctity of existing benefits and retirement payouts.

We already know about contracts and understand the legal obligations.  However, even contracts can be modified in the event of grave insolvency.

It is in everyone’s interests to avoid insolvency, but unless there are significant reforms, that’s what the city faces.

So, Mr. Zine, tell us something we do not know.  Simply supplying links to LACER’s reports doesn’t tell us anything new.  We also already know the rate of return assumption of 8% is unrealistically high and masks the full extent of the unfunded liability.

So, what pension framework are you considering? 

Until you share that, how are we to determine if you are really focused or just throwing the words “pension reform” around as so many of your peers do because it sounds good.   The growing number of taxpayers who are tired of bearing the risk of defined benefit pension plans want specifics. 

We want to be part of the dialog, but so far there is only a monologue. It might actually be a soliloquy given the dearth of information supplied by the Council Member.

Pension reform is the most critical issue facing the city. Zine should engage all constituencies.   He could start with the Neighborhood Councils.

Mr. Zine, we await your response.

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It’s easy to spell: R-I-S-K, but apparently Marshall McClain struggles with the concept.

Five-Year bonds issued by the government of Greece posted a yield of 10.88% as of the end of last week.  The yield on a Five-Year US Treasury was 1.9%. 

Which is the better investment?  If Greece does not default in the next five years, its bond could be a sweet deal.

But who knows? 

The same can be said about private equity deals.  I was being kind with McClain last week when I said his confidence in private equity deals as a yield enhancer was hubris.  His outlook can more appropriately be described as reckless.

One bad deal can wipe out most of the gains of any portfolio.

McClain referred to an example I provided a couple of weeks ago of how a single deal can explode as “anecdotal”  (Calpers wrote off a billion dollars from one investment). 

His dismissal of that event reminds me of a scene from the Godfather where Don Corleone is discussing a private equity deal of sorts with a rising drug lord.

Sollozzo: Bene, Don Corleone. I need a man who has powerful friends. I need a million dollars in cash. I need, Don Corleone, all of those politicians that you carry around in your pocket, like so many nickels and dimes.
Don Corleone: What is the interest for my family?
Sollozzo: Thirty percent. In the first year your end should be three, four million dollars. And then it would go up.
Don Corleone: And what is the interest for the Tattalgia family?
Sollozzo: I’ll take care of the Tattaglias, out of my share.
Don Corleone: So, I am to receive thirty percent for finance, for legal protection and political influence. Is that what you’re telling me?
Sollozzo: That’s right.
Don Corleone: Why come to me? What have I done to deserve such generosity?
Sollozzo: If you consider a million dollars in cash merely finance…
[raises his glass]
Sollozzo: Te salut, Don Corleone.

So, Mr. McClain, if a billion dollars is merely “anecdotal,” then “Te salut.”

By the way, Don Corleone did not think Sollozzo’s deal was “an offer he couldn’t refuse.” He deemed it to be too risky and politely dismissed Sollozzo.

The Don wasn’t going to back an aggressive deal with his own money on the line.

McClain’s own money is not on the line when the union pensions invest in private equity – it’s our money and I say we should politely dismiss Marshall McClain.

Despite his lack of regard for anecdotal evidence, McClain sure throws around enough of his own:  “This week, the Texas Teachers Retirement Fund just reported a 35% return in the past year, erasing much of the market losses they suffered in the 2008-09 market,” he proclaimed.

However, he fails to mention the statement of the TRS Chief Investment Officer when announcing the results:  “While the recent gains are very encouraging, we all know that this entire period has been exceptionally volatile and virtually unprecedented.”

Also, “erasing much of the market losses” means TRS still lost money. 

Furthermore, it is common to experience a big rebound from a low.  So don’t get too exuberant, Mr. McClain.  The markets are still roiling in volatility with no encouraging developments on the long-term horizon.

I’d dare say TRS has already seen some of its recent results evaporate.

Take a look at page 83 of the TRS investment summary and you will get an idea of the volatility over the last few years.

Easy come, easy go, when it comes to private equity investments. The State of North Carolina Pension Fund recently learned that close to $300 million of cash placed with private equity manager Terra Firma is now at great risk because of a single bad deal.

McClain and I can trade anecdotal examples or cherry-pick the data until the cows come home.  However, the fact that we are able to points to the volatility and lack of consistency in the markets.

Calculating valuations for private equity is an indirect process.  In some cases, price-earnings ratios of companies similar to a particular private equity investment are applied to forecasted earnings, but  no one really knows how a deal will pan out until it comes time to liquidate it.  What may have seemed like a winner a few years ago may now be a dog – a dog with fleas.  Private equity investments cannot be liquidated as easily or efficiently as securities in the broader market.  It could be tougher to unload a dog at other than fire sale prices in a limited market.

Maybe the municipal pension boards know more than Paul Volker, perhaps the most competent Federal Reserve Bank Chairman who ever served since the central bank was formed.

Volker wants the banks out of the private equity market because of the inherent risk and has advised President Obama accordingly.  He doesn’t want a repeat of massive bank bailouts of recent years.  His position is referred to as the “Volker rule.”

Congress is poised to pass a softer version of the Volker Rule, one which would limit private equity investment by banks to 3% of capital – not quite as strong, but still pretty conservative.

Pension plans, especially defined benefit plans, are a little like banks.  Participants deposit their contributions and assume the promised returns will materialize. As with banks, where most of the deposited funds are protected by FDIC insurance, the municipal pension participants are protected by the taxpayers.  If investments returns fail to materialize, the beneficiaries still get their pensions and the rest of us bail out the fund. Is that right?

McClain might believe I am against the concept of private equity.  Nothing could be further from the truth.  I just don’t want to cover the risk of an aggressive investment strategy.

Using a realistic rate of return assumption will show that the taxpayers are already at greater risk than officially recognized.  Warren Buffet recommends 6%. Using optimistic assumptions of close to 8% per year, such as McClain is suggesting, hides the exposure.

Unless participant contribution rates are increased to levels that shield the taxpayers from risk, then defined benefit plans should be replaced by contributory plans. 

If that should occur, then I would say “Te salut” to Marshall McClain.  Invest your members’ money as aggressively as you wish.

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No one covers the grimy details of local politics in LA as in-depth as Kevin James. 

Whether you love him or hate him, he has done a tremendous service for citizens by focusing on issues that are inadequately covered in most of the mainstream media. He does so responsibly and without rancor.

I was particularly grateful for his coverage of the CD2 election.  By contrast, KPCC (the local public radio affiliate) completely ignored the grass-roots candidates.

Kevin is moving to the 11PM to 1AM time slot, with former SNL and Monday Night Football personality Dennis Miller taking the 8PM to 1AM shift.

The moves were triggered by KRLA’s decision to bring Glenn Beck to the morning drive time segment.

I am not a fan of Mr. Beck. I rank him with such other unbalanced broadcasters as Keith Olberman and Chris Matthews of MSNBC and Sean Hannity of Fox and KABC. Besides, the last thing LA needs is a rehash of Beck’s views as heard on his Fox TV broadcast.  What we need is more debate over the local issues threatening our city.

There is a positive element to this schedule change – James plans on attending as many Neighborhood Council meetings in order to deliver a real grass-roots view of politics in Los Angeles.

I will certainly invite Kevin to attend a Neighborhood Council Valley Village meeting.

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Unless your calendar notes important occurrences or observations, you might not be aware that the sesquicentennial commemoration of the American Civil War is upon us.  

Some observers may have marked the start of the observance with the 150th Anniversary last year of John Brown’s Raid on Harper’s Ferry in October 1859.  Others use the firing on Fort Sumter in April 1861 as their benchmark. 

Both milestones would be appropriate. 

But between those two dates occurred what could be best described as America’s Twilight Zone – a period when the federal government was absolutely powerless.  

The United States came close to unraveling without so much as a shot being fired.  What’s more, no one could have stopped its dissolution.  The ramifications that would have had for the future of the world would have been unimaginable. 

The administration of James Buchanan arguably represented the weakest Presidency in our history.  He did little or nothing to bring the opposing factions, North and South, together.  Proactive was not a word in his vocabulary. 

His failure to intercede and restore some semblance of control at the federal level all but assured the fragmentation of political parties that led to the divided result in the Presidential Election of 1860

Source: Wikipedia

Upon taking the oath of office in March 1861, there was almost nothing Lincoln could do to reassemble the union.  Seven states had already seceded, with South Carolina leading the way in December 1860.  There was no desire for any of the seven to return under any conditions. 

The United States Supreme Court was not asked to opine.  It would have been unlikely any good would have come from it given the court’s previous pro-slavery ruling on the Dred Scott case and  Chief Justice Roger Taney being a slaveholder. 

How powerless was the government? 

Consider this:  the Army’s commanding general in charge of troops in Texas, handed over all posts to that state’s government and arranged for the evacuation of all federal troops without authority from Washington.   Although he was dishonorably discharged a couple of weeks later, it was a case of too little, too late.  The general was David Twiggs who went on to serve in the Confederate States Army. 

There was a little irony in the early months of secession – the United States Post Office continued to deliver the mail throughout the seven former states until the Confederate States established its own postal service in February 1861, so we can add secession to snow, sleet or hail. 

Lincoln would have done anything to save the Union and was on record as saying he would not interfere with slavery where it existed under the current laws. 

Although slavery was the core issue behind the Civil War, many Americans in the northern states were sadly ambivalent about it.  Many northerners did not want slavery in their own states, but did not care if it existed in the south. In some regions, there was fear that freed slaves would compete for jobs. 

Abolitionists were in the minority.  Lincoln was not an abolitionist.  If anything, his views on slavery may have been a little closer to Robert E. Lee’s than to Salmon P. Chase‘s, his rival for the Republican nomination .  Lincoln’s view of slavery evolved after the war started to the point where he positioned the conflict as a fight for freedom. 

Indeed, society in those days was not enlightened.  It is a paradox that while we waged a war to free slaves, the United States continued its policy of genocide against native Americans. 

The federal government’s lack of resolve would have been the end of a United States had it continued.  The Army was too small to interfere, and at least a third of its officer corp were southerners, many of whom resigned their commissions as their states withdrew from the Union.  Had Lincoln called for volunteers, almost all of the upper south, consisting of Virginia, Tennessee, North Carolina, Missouri, Kentucky and Maryland would have bolted rather than support what they would have perceived to be an invasion force – one that would have to march through their lands to reach the disaffected states of the deep south. 

Talk about being caught between a rock and a hard place, but that is where Lincoln was wedged. 

So what did he do? 

Other than keep the door open for the return of the seven states with a promise not to end slavery, he did almost nothing.  As it turned out, that was the smartest course of action. 

Lincoln’s patience won out over the Confederacy’s impatience.  By firing on Fort Sumter, the South aroused the passions of the North as no other issue could, including slavery.  

Gun mount at Fort Sumter

Although the commencement of hostilities did drive Virginia, Tennessee, Arkansas and North Carolina  to secede, the other border states remained largely loyal to the Union and served as valuable springboards for the invasion of the Confederacy.  It’s worth noting that Kentucky and Missouri were represented in the Congresses of both sides, but the impact was insignificant in the South’s prosecution of the war. 

You might say the Nation dodged a bullet by firing bullets.  Had the South been content with letting Fort Sumter wither on the vine, it is likely the North would have acquiesced.  America would have devolved into two nations, and perhaps fractured even further.  A precedent would have been set for other states to secede – California and the rest of the southwest may have formed yet another country in time.  There were a sizeable number of southern sympathizers in Southern California in 1861. 

The world is a better place because the United States remained united.  It is difficult to imagine how the world could have dealt with the challenges and epic upheavals caused by World Wars One and Two without the full weight of a nation as dynamic and resourceful as the one we know today.

Think about that this July 4th.

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The word on the street is that Council Member Tom LaBonge wants to raid NC rollover money to fill a deficit left in Proposition A transportation funds used to cover the cost of the City Council’s charter bus program.

The charter bus program shuttles constituents to and from their homes to City Hall to attend hearings.

The deficit is estimated between $700,000 to $2.2 million.

LaBonge apparently has support from some of his peers.  Whether they represent a majority is unknown.

I have heard that Council Member Krekorian is dead set against the proposal to raid NC funds.

It seems to me this should come from Council Member discretionary funds since it does benefit constituents.

This could be on the council agenda on July 1.

Details regarding the charter bus program and Proposition A can be found in this link:


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Dick Vitale is out with his preseason top 40 poll.

The top Pac 10 (or is it PAC 16?) program in the list in Washington at #16.

I’m happy to report Vitale places the Richmond Spiders at #29.  Admittedly, we can use more muscle inside.  Much depends on whether center Dan Geriot regains his all-conference form after coming back from a season ending injury the year before last.  He played sparingly last year.

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Who aren’t we boycotting these days?  OK, not China even with its human rights violations.  It’s OK to boycott Arizona but not the red light cameras manufactured there.

The LAUSD just added non-union car washes to the list.  The motion passed by the school board by a 6-1 vote cited the poor working conditions and low pay associated with the business.

Washing cars is a rotten job, but it is another consequence of having virtually no immigration enforcement and an ineffective government in Mexico which does little to provide social services for its population. 

Tamar Galatzan was the dissenting vote and the only one who drives (and apparently washes) her own car, so she does not add to the $78,000 per year the LAUSD spends on car washes for its fleet.

Galatzan’s concern was probably motivated out of a desire to instill at least an ounce of fiscal sense.  The LAUSD will be laying off hundreds of teachers. 

Don’t you think $78,000 could fund a teacher?  Besides, it would be good exercise for the LAUSD Board to wash and wipe their own vehicles once a week.

Personally, I wash my own cars.  I have more important uses for my money.  So should six members of the LAUSD Board with taxpayer money.

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My story appearing in today’s Citywatch refutes the baseless arguments of Marshall McClain, President of the Los Angeles Airport Peace Officers’ Association.

Marshall McClain’s rebuttal to my defense of Jack Humphreville’s and Alex Rubalcava’s positions on the unfunded pension liability crisis only proves that his sensitivity meter is registering in the red zone and needs recalibration.

He refers to my statements as “ad hominem attacks.”  His complaint is a typical reaction used by those who do not want to confront defects in their own logic.  It is similar, although not remotely comparable in its level of cynicism, to the hyperbole displayed by a handful of politicians who claim anyone who criticizes the federal government for not enforcing immigration laws is a racist.

“Shills” and “selfish” are apt descriptions for leaders who blindly support policies without consideration for the interests of other groups, especially groups that ultimately pay the tab for the outcome.  The words mean what they mean; I am not inclined to resort to euphemisms when there is so much at stake for the future of our government and quality of life.

It is also apparent that McClain dismisses the concept of risks.  He also disregards the sage advice, “past performance is not necessarily an indicator of future returns.” 

Everyone agrees with the “buy low and sell high” maxim he claims governs the investment strategy of municipal pension plans.  You don’t have to watch Jim Kramer’s “Mad Money” to buy into it; however, Mr. McClain conveniently ignores the real possibility of “buy low and sell lower.”  That is pure hubris on his part (Is that an ad hominem attack?  If so, forgive me).

Perhaps he does not want to acknowledge the changing economic environment the world faces.  As I stated in last week’s Citywatch:

Aggressive rate of return assumptions have no place in an economy rife with uncertainty.  McClain fails to recognize that the world is no longer operating under the forces of our fathers’ economy.  We have all been slow in recognizing the signs of change over the last few decades.  That’s why governments are in the mess they are today.  The largely predictable trends of the past provided a false sense of security regarding investment returns in many sectors – from the stock market to housing – and led to unsustainable government spending.  Downturns were always considered merely bumps in the road from which the markets would recover rather quickly.”

 Could McClain have a crystal ball?  If so, it is no better than one you would find for sale at a Las Vegas pawn shop.

The truth is there is nothing close to a consensus among economists as to the long term effects of the financial upheaval that has gripped markets for the last three years.  So is McClain’s outlook any better than yours, mine or the army of analysts that have expressed concern for the future?

He praises the private equity sector as the model for enhancing future returns.  One small problem – regulation.

Compared to established broader markets, there has been little regulation in the private equity sector.  That will be changing within a year due to recently approved legislation in Congress.  Regulatory compliance will likely represent a challenge for many advisers in an industry where privacy is relished.  Furthermore, venture capital firms are exempt from the new requirements, along with private equity firms managing less than $100 million in assets. 

Admittedly, regulation alone cannot completely stop charlatans from parting investors from their money.  That’s been proven with painful consequences.  However, formal regulation provides a framework for analytical improvements and for the administration of justice when people don’t play by the rules.  In any event, oversight will be a work in progress for years to come in the private equity sector. 

As with any emerging investment vehicle, fallout will result from investors’ exuberance.  Pension funds are not immune. Are there winning private equity sponsored opportunities out there?  Of course.  Are there losers?  You bet.  In the early to intermediate stages of a venture or project, the winners and losers can look alike. Long-term cash flow assumptions are subjective at best, especially for one-off deals.  Desire for higher yields coupled with potent sales pitches could lead to reckless decisions.

I agree with McClain when he says private equity firms play an important role by their involvement in the lending activities vacated by banks.  But defined pension plans, those with benefits determined irrespective of portfolio performance, have no business relying on investments that bear greater risks and are not subject to the everyday strict disclosure rules pertaining to publicly traded securities. 

Governing boards of state and local government defined pension plans have a responsibility not only to their plan participants, but to the taxpayers as well, to secure contractual promises with investments that are sound and as predictable as possible, something that McClain and other union leaders neither grasp nor desire to accept. Would these same leaders invest their children’s college funds in commodities, real estate deals, unproven technology or venture capital? However well projects may pencil out in projections, rational investors should be wary of uncertainty when it comes to decisions concerning the core of their nest eggs.

Responsible management of defined plans demands conservatism, even if it means lower yields. Lower yields will require higher contributions from the participants, but that’s the price you pay for a guaranteed benefit.  More aggressive investment strategies should be limited to contributory plans where the participants bear most of the risk.

McClain’s own words reveal what really concerns union leaders about using conservative assumptions – they want to protect their hold over their membership ranks, and the guaranteed pensions are the handcuffs they choose.  

He feigns concern for the taxpayers by saying conservative assumptions will mean they “will unnecessarily pay many millions of dollars each year into the pension systems of Los Angeles.” 

His real concern is that the taxpayers will revolt when faced with the real cost of defined benefit plans.  When that happens, there will be serious pension reforms passed faster than you can say Prop 13.  That’s the last thing McClain and his cohorts want to see.  It would mark the beginning of the end of their misguided dominance over their constituents.

You can read the previous stream of articles in Citywatch (recommend you read them in the order below):




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One possible ramification of the showdown between the DWP and the City Council over the $73 million transfer to the general fund could involve the SEC.

Let’s not forget the status of the DWP’s registered publicly traded bonds were at the core of the dispute.  Could there have been violations of federal security laws?  That’s what I am asking Senator Feinstein’s office to address with the SEC.

Here’s the text of my letter:

As you may be aware; there was a controversial conflict between the Los Angeles City Council and the Department of Water and Power involving the transfer of $73 million from the utility to the city’s general fund.

The DWP claimed it could not transfer the money without damaging its bond rating.  An audit proved otherwise.

The audit report went as far as to say that the DWP misled the City Council.  The City Controller agreed with the findings.

While this may appear to be a local issue, the DWP’s bonds are publicly traded securities registered with the SEC.  The confrontation initiated by DWP management may have impaired the value of the bonds.  In fact, the conflict did result in a downgrade.

Regardless, it appears DWP used the bonds as collateral to coerce the Council into acquiescing to its demands, without regard to the potential impact on the bondholders.

I would appreciate it if you would discuss this matter with the SEC and have the agency investigate the actions of the DWP.

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