Barron's - Jun 9th 2003

Hair of the Dog
By ALAN ABELSON

CHARLES BIDERMAN IS AN OLD PAL. He did time at Barron's and, indeed, even occasionally performed some strenuous and worthwhile digging for this column (a shameful activity we're certain he was wise enough to avoid including in his resume). Some years ago, Chuck decided to go straight -- or anyway, go straight to California, where he started his estimable and prosperous TrimTabs stock-market newsletter (that's a plug, and all subscription orders, Chuck assures us, will be gratefully accepted).

What prompts these warm reflections -- and actually, Chuck was a lot of fun and a top-notch reporter and analyst -- is that he sent us for our amusement and edification and, presumably for yours as well if we chose to pass it along, his latest commentary (see below). And after reading it, we do choose to pass it along.

The subject is the State of Illinois and more particularly its pension fund. According to Chuck, Illinois can claim the dubious distinction of a huge gap -- perhaps the hugest among all 50 states, for all anyone knows -- between its pension-fund assets and expected future liabilities. Which leads him to the not completely off-the-wall conclusion that the state has done a less than superlative job of managing its pension fund.

Unfortunately, exactly how bad was the fund's performance and especially that of the equity part of the fund, Chuck concedes, is difficult to say because no one who might be able to enlighten him on that score answered his telephone calls.

In any case, last week Illinois sold $10 billion worth of five and 10-year pension-fund obligation bonds, with taxable coupons of up to 3 5/8% for the 10-year paper. Obviously, undaunted by its seemingly less-than-stellar past experience, the pension fund believes it can earn more than a 3 5/8% annual return in the next five-to-10 years by investing in stocks. The fund has not, as far as can be discovered, disclosed the basis for such confidence in its investment prowess. Chuck's speculation in this regard is that it likely stems from assurances by interested professionals that the equity market is destined to rise at least 8% a year from here till eternity.

Besides the need to eventually pay back the $10 billion, Chuck observes, the fund will have to earn enough to more than pay the interest on the bonds. For, he notes, the offering circular reveals that part of the $10 billion will be used to recompense the Illinois general fund for past pension expenses the general fund graciously absorbed. How much of the $10 billion is ticketed for that purpose he isn't able to say because of the aforementioned failure to respond to his phone calls.

Chuck sees Illinois' ingenious initiative as part of "a new bubble in the making." Especially, it strikes us, if other states follow its lively lead and float bonds to play the stock market.


Taken from TrimTabs Overnight Liquidity Update - Thursday 5th June, 2003

New Bubble in the Making!

The State of Illinois reportedly has the biggest gap between state pension fund assets and expected future liabilities of any of the 50 states. For that to happen, the State of Illinois has to have done a horrible job managing the fund. We have been trying to reach either the state Treasurer's office and/or the state's Office of Management and Budget to find out the actual annual performance of the equity portion of the state's pension fund. No one has called us back as this is being written.

The self-same State of Illinois this week sold $10 billion in five and ten year pension fund obligation bonds with taxable coupons up to 3 5/8% for the longer dated paper. That reportedly is the fourth largest offering by a municipality.

Obviously the Illinois state pension fund, that apparent source of dreadful historic equity performance, is willing to bet they can earn more than 3 5/8% in the equity markets over the next five to ten years. After all, scratch an actuary and they will guarantee that the equity market will rise at least 8% per year going forward, just as certainly as the sun rises in the west.

In addition to eventually paying back the $10 billion, the pension fund apparently had better earn even more than just enough to pay the interest. Why? The Offering Circular says a part of the $10 billion will be used to pay back the Illinois general fund for already spent pension expense -- how much we don't know. That means to us, remember no one has called us back, that some of the proceeds is going back to the state to cover the current budget deficit.

In other words, this year Illinois won't have to raise taxes nor cut spending on salaries (few states provide any real services other than transferring income from taxpayers to state employees) to the extent of the money stolen from the pension fund, Illinois is now in the gambling business. Our bet is they crap out.

There is no truth to the rumor that Tony Soprano was the low bidder on managing the Illinois $10 billion and also no truth in the story that the ghost of Richard Daley came in second lowest.

Why what Illinois is doing is significant is that the remainder of the $10 billion in cash from the bond market will be going into the equity market. Talk about dumb money! We also hear that foreigners have been buying recently, particularly since those who aren't TrimTabs clients mostly missed the March-April rally.

Then there are the 5,000 or so hedge funds that were bearish in March-April and are now turning wildly bullish on both stocks and bonds. Since Greenspan's use of the word "deflation" our guess is many hedge funds have been using 90% to 95% leverage to buy governments. That leverage enabled pension funds to get a good price on their bond
sales to fund equity purchases.

To add to the above list of investors who usually turn wildly bullish when the market is topping out, individuals have pumped $3 billion into equity funds the first three days of June. That's the first decent inflow since mid-April tax-time.

On the other hand, another $2 billion of new offerings got sold last night, $4.5 billion the past three days.

Add the dumbest investors being willing to borrow to buy stocks to the billions in converts with low or zero coupons and premiums as high as 100%. The obvious result is a bubble in the making. When it pops, look out below.

We again are too early. We turned bearish in February 2000 and felt foolish for a couple of months. We turned bearish in mid-October 2001 and were chagrined until December.