Monday, October 26, 2020
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VRS and the Derivatives Craze

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An AFL-CIO tweet yesterday jogged the memory. During the conclusion of Frontline's series on the financial meltdown, the sorry tale of Larry Langford and Jefferson County, Alabama's dance with derivatives had already created a question. With all of Delegate Purkey's huffing about VRS, he's never mentioned this.

Readily available information is insufficient to determine if future Virginia retirees should consider themselves fortunate, but they seemed to have dodged the bullet during a flight to risk taken by their pension trust. Standard accounting and reporting procedures have changed since the meltdown of 2008, but what is clear is that at the end of the last available reporting period (June 30, 2011) the fund had unwound itself from a derivatives position of nearly $7 billion reported in 2009 to a much more reasonable (but not necessarily justifiable) $1.3 billion.

What Delegate Purkey (R-Virginia Beach) has claimed is the result of his committee's hand on the steering wheel, The Virginia Retirement System reported a one year return on investment of 19.1% last year. But what the fund holds in assets is an amount less than that reported three years earlier: $51.3 vs $51.7 billion. So a three year decline of half a billion dollars. Not bad at all, considering the turmoil during that time.

But here are some questions:

  • What was the net return on the derivatives?
  • Was the risk inherent in the derivatives justified?
  • If the return has justified the risk, why unwind?
  • Would a flight to quality have provided a similar return without the risk?

One other question: Will Bob McDonnell repay VRS with the 33% two year gain the funds would have earned had they been paid when obligated?

Money, Power, and Wall Street: The Financial Collapse

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By March 2008, the prospect of a meltdown was looming. Bear Stearns fell first. It started with rumors about investment in sub-prime mortgages, tagged as toxic assets. Bear Stearns bought hundreds of thousands of sub-prime mortgages and bundled them. Little then did candidate Obama know the role he would play.

This continuation of the Frontline documentary takes up with the events of 2008, a Presidential election year. In this installment, the very foundation of the financial world trembles while we meet the major players: Secretary of the Treasury Hank Paulson, Chairman of the Federal Reserve, Ben Bernanke, and Tim Geithner, president of the Federal Reserve Bank of New York.

Tim Geithner distinguished himself from the moment he received the first panicked call. Instead of acting without intelligence, he dispatched a team to survey the situation at Bear Stearns. They and teams from the SEC and JP Morgan discovered a drowning pool of toxic assets. Bear had made credit default swap deals worth trillions of dollars that had infected all of Wall Street and the financial world. Geither recognized the systemic risk to the world economy. This was the moment of realization that Bear Stearns was too big to fail. This took Federal regulators by surprise.  

Money, Power, and Wall Street: an Invisible Market

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The myth of a strong economy heralded by the Bush administration unraveled in a series of Wall Street financial earthquakes. $11 trillion of America's net worth dissolved; 8.5 million jobs were lost in the resulting recession. People's homes weren't worth what they paid for them. College graduates moved home.

"The real story of this financial crisis is not so much whether the bailout was the right thing or the wrong thing to do. The real question is: How did it come to be?" - Phil Angelides, Chair, Financial Crisis Inquiry Committee

This beginning of a PBS Frontline documentary depicts the dramatic succession of events that led to and through the financial cataclysm that altered the economic landscape. In the first installment, events leading up to the 2008 crisis are brought into focus. Some of the key players are introduced. Most important is the development of a financial layman's understanding of the complex machinations involved.

It didn't begin with credit default obligations (CDOs) but that is as good a place as any to start explaining this mess. A group of innovators at JP Morgan developed the concept of a derivative to trade loan risks in the early 1990s. That is where the Frontline documentary begins the journey through a sorry tale of a failed economic credo and its victims.