Wall Street or Sacramento, the hubris is the same

The financial meltdown was, at is core, a testament to the hubris of smart financiers who thought they could master risk, but failed miserably. To earn an extra percentage point (or less) on their returns, they created complex derivatives that provided no protection when it turned out the subprime mortgages they bought from Fannie Mae (and its lenders) were all junk.

It’s not just Robert Rubin at Goldman Sachs or Richard Fuld of Lehman Brothers, but even America’s largest public pension fund: CalPers. The one that covers California state employees (outside the UC) that I was hoping would pay me $3K/month when I retire at age 65.

CalPers invests on behalf of 1.6 million members and retirees. Its staff reports to an elected and appointed board, which is packed with union members and ruling party politicians (nowadays Democrats with one token Schwarzenegger Republican). Despite being thousands of miles from Wall Street and nominally with a public service (or at least public employee) ethos, CalPers showed the same hubris in making risky investments, particularly in heavily leveraged land deals that once accounted for 20% of its portfolio.

The WSJ reports:

For the quarter ended June 30, Calpers says it expects a loss even greater than 100% for its once high-yielding land and housing investments, thanks to its use of borrowed money on deals. The losses also dragged into negative territory the quarterly returns on its overall $22 billion real-estate portfolio, typically one of the pension fund's most profitable.

One of its biggest (and most disastrous) land investments was a majority stake in the planned Newhall Ranch, 15,000 acres of undeveloped land north of Los Angeles, once appraised at $2.6 billion. When the economy slowed down (even before bloody October) tract development ceased, the developer filed for bankruptcy, and now its lender wants to liquidate the land (which today would be at firesale prices).

Back in February 2007, CalPers announced that it implemented a risk management system:

CalPERS recently implemented the large-scale CalPERS Risk Management System - a comprehensive framework for measuring, monitoring, and managing risk. The key goals of the Risk Management team are to achieve an enterprise-wide view of the investment and risk profile at CalPERS, increase return on risk taken, and establish an appropriately focused risk culture.

I suppose it could have been worse, but as a CalPers member I’m not at all reassured that they did anything to solve the risk problem.

The WSJ also reports that many CalPers investment managers are leaving. Are they suffering any more consequences for their bad decisions than the Fuld or Rubin or Jimmy Cayne or Franklin Raines? Probably not. Certainly none of the politicians or union members will suffer any consequences for their failed oversight.