Bethlehem City Pension Investing in Hedge Funds

Bethlehem Business Administrator Dennis Reichard is currently exploring the idea of buying out some long-time employees. Based on an independent audit showing that the City finished last year $8.5 million in the red, he might want to start with himself. Among many other problems, Bethlehem actually missed its annual $2 million pension contribution last year. A few years before that, Mayor John Callahan had to borrow $34.6 million to make up a shortfall in the police and fire pensions. Now, it appears that City pensions are investing in hedge funds, and enough to bother the City's independent auditor. Let me fill you in.

$34.6 Million Needed to Replenish Pension Fund

Between 2000 and 2002, a combination of bad investments and unforgiving stock market led to a $20 million loss in the Christmas City's fire and police pensions. Ho. Ho. Ho. In 2004, the State ordered Mayor John Callahan to come up with $34.6 million, enough to cover both the loss as well as the amount the City should have earned over those two years.

Conocrd Public Finance, now a faithful Callahan campaign contributor, was only too happy to propose one of those painless bonds. You know, the kind where you make no payments at all the first year. They added this "will not have a negative impact on the City’s credit rating."

Council member Jay Leeson had no interest in the Municipal Novocaine being offered by Callahan's Financial Dentists, but was instead concerned this was probably the worst fiscal crisis in Bethlehem's history. "[T]he origin of the City’s crisis dates really back to a pattern of borrowing from Peter to pay Paul, and draining the surplus funds from municipal authorities, such as the Bethlehem Authority, the Housing Authority, the Parking Authority.”

As we've since learned, things could and would actually get worse.

Leeson argued the only way out of this crisis was Municipal Root Canal, a tax hike. "You don’t borrow money and then invest it in the stock market unless you can afford to lose it. But that is essentially what we are doing is borrowing money to put it in the equity markets. That assumes we can afford to lose it. We cannot afford to lose it, given the circumstances that the City is in. We cannot afford to assume that risk."

This was unthinkable to Mayor John Callahan, who insisted (in 2004) that the City had turned the corner economically, that Leeson is just painting "doomsday scenarios" while he "rolls up his sleeves" a lot and presents "creative solutions." People like Leeson are just "irresponsible."

Callahan's pain-free bond was approved, after which the City's credit score was reduced by S&P. Subsequent years proved Leeson was, if anything, too optimistic.

City Misses $2 Million Pension Payment.

Last year, the Callahan administration demonstrated its creativity and responsibility by missing its annual pension payment, set at $2,047,975. It finally caught up in April, thanks to the casino. Bethlehem was required to pay $139,198 more than if it had paid on time, but the City denies this is any form of late fee or interest penalty. It probably would be irresponsible for me to make that suggestion. City administrators assure Council President Bob Donchez it will never, ever, ever, ever, ever, ever, not ever ... ever happen again. Ever.

I'm sure this will have no impact on the City's next S&P rating.

Despite $20 Million Loss and Missed $2 Million Payment, City Pension Invests in Hedge Funds

At last week's Finance Committee meeting, City Council President Bob Donchez was understandably concerned when auditor Tracey Rash mentioned "unusual investments" in the City pension fund. (You can see their exchange here).

Donchez: "This pension investment. Is this something that you're concerned about? Because if we go back to 2006 ... 2005, we took a bond out for the pension, to fund it. Is this a very high risk or am I completely wrong?"

Rash's answer? "I can't address the risk associated with the investment. What I can say is that it caught my eye because it wasn't a typical investment in a pension fund. ... It was enough to make me look at the pension investment law and make sure you were in compliance with the law and make some inquiries to your Solicitor and Financial Advisor."

Translation. "Are you folks out of your frickin' minds? After borrowing $34.6 million and then missing a pension payment completely, why the hell are you investing in something this stupid?"

The two investments that caught Rash's eye are in Graham Global Investment Fund & Green & Partners, LP. A google search quickly revealed that these are hedge funds.

What Exactly Are Hedge Funds?

According to a Securities and Exchange Commission (SEC) staff report, a Hedge Fund is "an entity that holds a pool of securities and perhaps other assets, whose interests are not sold in a registered public offering and which is not registered as an investment company." It's a $2 trillion industry where managers are not required to report how much money they oversee or how much money they make or lose each month. As explained in an University of Maryland article, hedge funds are unregulated and exempt from SEC disclosure and registration. This enables them to earn much higher returns than your usual mutual fund, but they are more risky. "They are highly secretive investment vehicles." Wall Street reforms have had no impact on them, either.

New York City's three pension funds for police officers, firefighters and civil employees are considering investing in these loosely regulated hedge funds. According to a CFO at one of the Lehigh Valley's leading corporations, they do deliver positive returns, even in a down market. He considers them a legitimate option to diversify a large size pension fund. But this assumes the fund selected has a successful track record, something Bethlehem's pensions funds can't claim.

That University of Maryland article tells us 326 hedge funds went out of business in the first half of 2006. In May 2007, two Bear Stearns hedge funds lost approximately $1.6 billion of capital due to overexposure to bad mortgages. Likewise, the Swiss banking firm UBS AG shut down a hedge fund in May 2007 that lost more than $124 million from similar bad investments. In the UK, public and private pensions alike are wary of hedge funds because of their perceived risk, potential for big losses, and concerns about a lack of liquidity.

In the eyes of their detractors, hedge funds are little more than a Ponzi scheme. “There were accepted practices going on in the industry up until 2008 that in retrospect look like a problem. Funds were using the liquidity of incoming investors to pay out the established investors without testing the investments themselves. It was hard to see this until everyone hit the exit at once and everyone starting asking for their money back at the same time."

Given Bethlehem's troubling history with its pensions, it's no wonder that these investments bother Rash.

Why Don't Hedge Fund Investments Bother Mayor Callahan?

On his Congressional Facebook page, asks, "Where was Congressman Dent when Goldman Sachs sent up to $4.3 billion in taxpayer fund to overseas banks?" He's "glad that the Wall Street reform bill passed last night because it eliminates taxpayer funded bailouts and holds Wall Street CEOs accountable."

Does Callahan realize that money invested in hedge funds could easily go to offshore accounts? Has it dawned on him that there is no accountability at all?