The Federal Deposit Insurance Corporation (FDIC) is trying to get public pension funds to help prop up failed banks by buying into them, reports Bloomberg. Such a move would almost certainly run afoul of pension fund managers’ fiduciary duty, by investing in excessively risky assets. Indeed, the risks are obvious.
Oregon would invest in Community Bancorp LLC, a bank being formed by Sageview Capital LLC, according to the Oregon presentation. Sageview was founded by former Kohlberg Kravis Roberts & Co. executives Scott Stuart and Ned Gilhuly. Sageview is looking to raise about $1 billion from pension funds and similar investors, the presentation said.
While the structure makes sense, pension funds would be better off investing in existing banks, said Chris Whalen, managing director of Institutional Risk Analytics of Torrance, California. At those lenders, management will oversee details of buying failed lenders and save pension funds the time and effort needed to launch a new bank, he said.
“If they are really interested in playing this area, they should put their money into a larger bank that’s already playing here,” Whalen said. “If you look at the risk-reward and the distraction involved, it’s not worth it” to back a new bank, he said.
Investing in distressed banks doesn’t always pay off, as the U.S. Treasury Department learned with the Troubled Asset Relief Program. At least 60 lenders skipped some of their promised dividends to the TARP fund, according to SNL Financial, and a $2.33 billion stake in CIT Group Inc. was wiped out last year when the lender went bankrupt.
And who will then be on the hook when such investments go south?
FDIC guarantees may soften the risk of investing public pension money in distressed banks, Whalen said. When the FDIC sells a failed bank, it typically shares a portion of the loan losses.
This perfect storm of moral hazard and excessive risk cannot end well. Moreover, as former Labor Department official F. Vincent Vernuccio notes, some public pension funds already suffer from under-performance due to politicized investment strategies adopted by their managers.
[I]n June 2009, 41 signatories representing some of the nation’s largest public pension funds and others with approximately $1.4 trillion in assets wrote to the Securities and Exchange Commission, asking the agency “to improve disclosure of climate change-related risks, and material environmental, social and governance risks, in securities filings.” California State Treasurer Bill Lockyer, who serves on the governing boards of the California Public Employees’ Retirement System (CalPERS) and the California State Teachers’ Retirement System (CalSTRS), put climate change on par with protecting retirement funds, saying, “Pension fundsprotect workers’ retirement benefits, and they need to ensure their portfolios reflect the risks and benefits related to climate change.”
Lockyer’s endorsement of using pension funds for anything other than retirement security is particularly brazen considering the huge losses that CalPERS and CalSTRS have sustained in recent years due to PTI investments. In 2000, then-California State Treasurer Philip Angelides launched his “Double Bottom Line” initiative to adopt certain social and tobacco-free investment policies—including using the pension funds in CalPERS and CalSTRS for local economic investments. The divestment of tobacco was a costly mistake. CalSTRS revealed that its tobacco investment ban lost the plan $1 billion in gains, and in 2008 conceded that they “could no longer justify” avoiding tobacco stocks.