This is the nightmare scenario: pension funds invested in CDOs and/or other derivatives are swamped by the massive unwinding process underway. Where then does the money come from to pay retirees?
This great unwinding has potential consequences not only for U.S. pensioners, but certainly the U.K. and possibly beyond. Here is a terrific and concise explanation of the relationship between CDO downgrades and U.K. pension funds by Ken Griffin and Jeff Moskowitz:
“When Standard & Poor’s last week issued a warning about so-called collateralised debt obligations (CDOs), a complex financial instrument made up of repackaged tranches of debt . . . in many cases high-risk ‘subprime’ mortgage loans offered to high-risk borrowers . . . most assumed that the worries were limited to US financial markets.But the Sunday Tribune can reveal that more than 80% of the CDOs being put on a credit watch by S&P are listed on the Irish Stock Exchange (ISE), which may expose European pension funds to America’s subprime meltdown.S&P confirmed last week that it may cut the ratings of bonds issued as part of 118 debt transactions, 95 of which have their European listing in Ireland.”
“A spokeswoman for the Financial Regulator, which jointly authorised the listing of the bonds with the ISE, declined to comment. When asked about the pension implications of the listing of the bonds, she said that it was not a matter for the regulator and that ‘you would have to talk to the Pension Board in relation to that’. Pension funds and hedge funds have been attracted to the transactions because they offer higher, but riskier, returns than conventional bonds. In many cases even pension funds that don’t own bonds issued as part of CDOs are still exposed to the market through their investment in hedge funds. ” http://www.tribune.ie/article.tvt?_scope=Tribune/Business/Business+Week&id=73306&SUBCAT=Tribune/Business
Always on the lookout for a higher return (perhaps at the expense of safety?), even pension funds that are not allowed to invest directly in real estate nevertheless may actually be invested in real estate through “creative” derivative instruments. As an example, click on this link for a new derivative offered to pension funds in mid-2007:
Was this a good idea?