The Real Crisis in Health Care?

This morning I watched all the debates on health care reform on ABC's This Week. There was a particularly heated exchange between Karl Rove and David Plouffe (watch part 1 and part 2).

As a Canadian, I watch all this fear mongering going on in the US, and can't help shaking my head. Words like "Armageddon" are being thrown around, and that if this health care bill passes, the US will collapse. This is just a bunch of nonsense.

But I'm not going to discuss the merits of this health care reform. Instead, I want to talk to you about another calamity going on right now across many states. Sasha Abramsky of the Guardian reports that homeless and mental health services in the US are being cut back as cities, counties and states run out of cash (HT: Sam):

Recently, I wrote about public education in crisis. But two other vital public services are also being hit hard by budget cuts: mental health care and assistance to the homeless.

Education is at least partly buttressed by the fact that almost everybody supports the idea of public schools. Cuts generally provoke an outcry, and politicians often pledge to do their best to restore funding as soon as the economy improves. Mental health and homelessness services, by contrast, are in some ways more vulnerable over the long-run: the constituencies they serve tend to be perceived by much of the public as nuisances at best, as societal menaces at worst; services to these groups tend to be costly; and the success rates (illnesses controlled, homeless folks moved into permanent housing) are, while a whole lot better than nothing, sometimes mediocre.

And so, as local and state government budget crunches worsen, it's no surprise many of these services are on the chopping block.

The Centre on Budget and Policy Priorities (CBPP) reports that Connecticut's governor has proposed suspending all state-funded homeless services for the rest of the fiscal year; California has eliminated funding for domestic violence shelters; Massachusetts has reduced spending on geriatric mental health services; Ohio has, according to the CBPP report "eliminated virtually all state funding for mental health treatment for individuals who are not eligible for the state's Medicaid programme"; while Virginia has reduced the amount it pays hospitals to treat people with mental health or substance abuse issues and slashed its grants to local mental health service providers.

In fact, search online for mental health cuts by state, and it rapidly becomes clear that across America the already-fragile community mental health service infrastructure is being battered.

The impacts are by no means abstract. Community mental health clinics provide not just medicines and counselling services, but an array of other support: they help the mentally ill find housing and jobs; and they work with them to navigate complex government bureaucracies and access benefits. They provide friendship to people who are frequently lonely, depressed and marginalised from the broader community. Cuts to the mental health infrastructure in Kansas have resulted in a documented increase in calls to suicide hotlines and rising numbers of people being admitted to psychiatric hospitals in a psychotic state. Communities like Santa Barbara, California, have seen homelessness spike at least in part because broke local mental health services are having to turn sick men and women away.

And, once homeless, the mentally ill – as well as the non-mentally ill homeless – face a similar scramble for scarce resources. Tens of millions of dollars have been removed from city shelters in Washington DC, the nation's capital. As winter set in last November in Minnesota, one of the coldest states in America, thousands of low-income families lost emergency financial assistance to help pay rent to avoid being evicted. The National Coalition for the Homeless estimates more than 700 homeless Americans die of hypothermia each year – and with homeless services being slashed, that number will likely increase in the years to come.

Meanwhile, New York City is considering closing the largest homeless drop-in centre in Manhattan. Activists worry that homeless residents with drug addictions, HIV, tuberculosis, or mental illnesses will find it harder to access treatment if they aren't in stable housing situations. And that, ultimately, could trigger a broader public health problem.

In cities, counties, and states across America, homeless and mental health services are being eviscerated. As a result, programmes that have been carefully built up over decades are going to close. With them will go the expertise of trained staff; the accumulated experience of caseworkers who have gotten to know the needs and behaviours of individual clients, and who might have spent years getting those individuals to trust them enough to let them provide help; and the fragile bonds, the sense of belonging, that in some instances are the only things keeping a person on the edge from spiralling into more serious illness and more intractable long-term homelessness.

There are no easy answers here: too many branches of government have simply run out of cash and of quick-fix solutions. Without more support for these programmes from the federal government, or local ballot measures that earmark funds for particular social services, it's inevitable that many of them will be cut in the next few years.

But, at the very least, this merits a frank conversation, an acknowledgment that the risks associated with dismantling this infrastructure are huge: tear down services to these groups during the down times and there is just no guarantee that a political consensus will emerge at the back end of the fiscal crisis to restore such services. After all, homeless people or the seriously mentally ill don't tend to have much of a political voice. Their needs are, too often, seen as irrelevant.

The undermining of these vital social services will have an impact that long outlives the current economic crisis. Nothing would more forcefully illustrate the phrase "private affluence and public squalor", coined by progressive economist John Kenneth Galbraith, than a booming America, its landscape littered by ever more homeless encampments, ever greater numbers of untreated mentally ill people and, in consequence, a growing sense that, for the affluent majority, public spaces are unsafe and unseemly. That happened in Victorian England; it occurred again in both America and the UK in the 1980s. It would be a great tragedy to let the 2010s and 2020s witness a repeat performance.

Treating the mentally ill is not just a US problem. In the UK, Maddy Savage of the BBC reports that GPs call for better treatment for depression sufferers:

Some 65% of doctors say they can "rarely" offer psychological therapy to depression sufferers within two months of referral, a study suggests.

The Royal College of GPs survey of 590 UK doctors also found 15% said access to psychological services was only "usually" possible in that timeframe.

The survey is part of a campaign by mental health charity Mind calling for better access to therapies.

The government says it is working hard with the RCGP to achieve this.

Depression affects one in 10 people a year, with more than half of those experiencing more than one episode.

Manifestos

The National Institute for Clinical Excellence (NICE) recommends talking therapies as the best form of treatment for mild and moderate depression.

Mind's campaign is being backed by the Royal College of Psychiatrists.

It challenges all political parties to make a guarantee in their election manifestos, to offer evidence-based therapies to all those who need them within 28 days of requesting referral.

In 2007, the government earmarked £173m to boost the number of cognitive behavioural therapists available on the NHS.

The Improving Access to Psychological Therapies (IAPT) programme aims to treat 900,000 extra people in England by 2010/11, with half of them moving to recovery and 25,000 fewer on sick pay and benefits.

RCGP chairman Professor Steve Field said: "There has been substantial improvement in the last few years but there is a long way to go.

"It is essential that the current programme is completed within the next Parliament with adequate funding for training and employing extra therapists.

"If we can treat people early we can keep people in work, keep them off medication and help them get on with their lives."

Mind chief executive Paul Farmer said talking therapies could save lives, and it was crucial that people who needed help received it as quickly as possible.

"Waiting months and months for urgent treatment would not be acceptable for patients with other health problems, and it should not be acceptable for patients with depression," he said.

A Department of Health spokesperson said more than 230,000 people had already benefited from the IAPT and that almost three quarters of primary care trusts now offered this service, up from a quarter two years ago.

But in a statement it added: "There is still work to do and we will work closely with the Royal College of GPs and others to achieve this."

'Misery'

Opposition parties have also pledged to widen access to talking therapy treatments.

Tory shadow health minister Anne Milton said: "In the same way that physical conditions get worse when not treated, a mental health condition will also deteriorate. This must be improved.

"We will make sure that GPs have better information about the effectiveness of talking therapies."

A Lib Dem spokesman said: "We are totally committed to ensuring that people with mental health problems are given guaranteed access to the treatment that they need and we want to work with Mind and the Royal College of GPs to find out what the spending implications would be of a 28-day guarantee."

The programme director for Wellbeing at the London School of Economics, Professor Lord Layard, who is spearheading the campaign, has stressed the economic as well as the humanitarian case for investing in treatment, suggesting that successful therapy can help many people return to the workplace.

"Mental illness is perhaps the greatest single cause of misery in our country," he said.

"The least we should offer is the same standard of care we would automatically provide if they had a physical illness."

So, as you listen to the news touting the historic passage of US health care reform, keep in mind that millions of people who suffer from mental illness are falling through the cracks and not getting adequate treatments for their conditions.

I should know, I see my father, brother and their colleagues on the front lines, treating the mentally ill day in and day out. Despite the popular belief that the recession causes more mental illness, my father keeps telling me that "at any one time across all populations, 10% suffer from depression". That's a lot of people in the world who need to be treated for a serious condition.

Unfortunately they're falling victims to state budget cuts and they do not have the political clout to fight for better access to treatments. In that sense, the recession has impacted millions of silent victims who struggle to cope as resources dwindle. This is the real crisis in health care that hardly anyone covers.

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Europe's Commercial Real Estate Timebomb?

Graham Ruddick of the Telegraph reports that Europe facing commercial property timebomb (HT: John):

Europe faces a commercial property debt timebomb with almost €1 trillion (£896bn) outstanding from the sector and a quarter of that potentially distressed.

The UK accounts for 34pc of the €970bn total, with Germany second with 24pc, new research shows.

The scale of commercial property debt in the UK, and the precarious nature of much of it, has been flagged by the Bank of England and the Financial Services Authority as a threat to the recovery of the economy and the banks, but the report by CBRE highlights that it is an issue for most of Europe.

According to the property agent, €207bn of the debt is secured at high loan-to-value ratios on poor quality real estate, and is therefore most at risk of not being repaid. Of this, €89bn, or 43pc, is from the UK, and €69bn from Germany.

Also, the debt is maturing at a rate of €155bn a year, meaning almost half will have matured by the end of 2012.

There are concerns about the repercussions of the outstanding debt following sharp falls in commercial property values since 2007, which has put pressure on loan-to-value covenants and eroded equity. Tenant failures and declining rents have also affected income for property owners.

Natale Giostra, head of UK debt advisory at CBRE Real Estate Finance, said: "Germany and the UK saw some of the highest levels of gearing at the top of the market in 2006-07 and so are likely to have a higher proportion of problem debt arising from highly geared loans."

What banks do with distressed property assets on their balance sheets is the key topic of discussion at the annual Mipim property conference in Cannes.

Dennis Watson, managing director of property and project finance at Barclays Corporate, has said the banks are likely to increasingly turn to joint venture and asset management agreements with property companies to nurse their assets back to health.

One leading agent in Cannes with knowledge of the loanbooks of Royal Bank of Scotland and Lloyds stressed they had major exposure to secondary offices and shopping centres outside London – an area where demand from buyers remains weak – meaning widespread asset sales would be difficult.

Robin Hubbard, executive director of CBRE Real Estate Finance, said banks could take 10 years to unwind their exposure to distressed commercial property.

No worries, I am sure Canadian, US, European and Asian pension funds will be buying European commercial property at "distressed prices". Only problem is that they might be sitting on those properties for a lot longer than they bargained for. And then there is that nagging issue of US commercial real estate, which seems to headed towards a crash of unprecedented magnitude.

Pension fund managers will tell you, "don't worry, pensions invest for the long-run". True, but in the meantime, they're going to get creamed on their commercial real estate holdings and they need to find a way to make up for those losses in liquid public markets, which will also suffer if banks cut risk to bolster their balance sheets. Correlations always come back to haunt you at the worst of times.

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Where Do Pensions Stand on Post-Crisis Reforms?

Hugh Wheelan of Responsible Investor asks, Where’s the real sustainable investment collaborations?:

In the same week that we recorded a year of post crisis bull market, a 2,200 page report on the Lehman Brothers debacle thwacks down on desks. The former is a reminder that governments pulled financial markets back from the brink and, somewhat controversially, created the monetary conditions for banks to quickly return to profit, despite bearing a large portion of the blame for the economic meltdown.

Not surprisingly, the recent joint poll by Responsible-Investor.com, the Network for Sustainable Financial Markets and AQ Research, showed more than 90% of investment professionals believe moral hazard has increased.

The Lehman report is a dead-weight memorandum of market folly that looks set to whip up yet more legal cases and send a chill wind through the audit profession.
 But what in the markets has fundamentally changed? Shockingly, the diagnosis is little, if anything.
 An estimated $11 trillion of global GDP wiped out according to best estimates, 200 million job losses, but no proper reform. For investors, a lost decade of returns, yet barely a peep from them about systemic issues.

No wonder customers lack confidence in those who should be looking after their interests.
 The life-support machine for the banks, as well as the economy – government intervention – has worked. The “patient” is rehabilitated, with assets recovering, but that is of little comfort to the millions who have suffered from this recession. Time then, it seems, to start right back on the narcotics.

OK, perhaps a little worthwhile lifestyle change here and there: some tougher corporate governance, some attention to excessive bonuses, rehashed talk about long-termism. 
But, as I’ve argued before, little action on the continuing toxic dangers of off-balance-sheet banking, the destructive nature of some derivatives, clarity in audits, elimination of conflicts of interests amongst credit rating and sell side research agencies.
 These are core to the protection of investor rights.

In addition, as Lord Turner, chairman of the UK Financial Services Authority, argued in a speech this week, politicians and regulators need to rethink the view that more lending, greater liquidity and bigger markets are always better, whilst looking at transaction taxes and higher capital charges to curb risky trading that does not stimulate real economic growth. Institutional investors need to be at the heart of these vital discussions too.

Reports from the US, and elsewhere, indicate the potential for patient credit crisis relapse: housing foreclosures remain at dangerous levels while governments take their feet off the monetary gas in a continuing febrile economic climate. Who can say with confidence that they trust all the asset valuations on banks’ books, or have full faith in credit lines and the ability of companies to currently refinance debt? 
In today’s complex financial world, it’s worth going back to basics. Institutional investors exist to invest their customers money over the long-term. The sustainability and proper functioning of financial markets as well as the greater economic well-being of the economy and society is at the heart of their mission and their fiduciary duty to their beneficiaries.

The inter-generational savings deal is vital to their political and economic viability. Hence, the traditional view that the essential role of the financial services sector is to facilitate the allocation of capital to economically productive uses.
 These are useful road markers most institutions can agree on to chart a way forward in markets that have become systematically predatory and socially unpopular. Institutional investors are large, influential players in the market. And markets are not neutral. Deregulation (aka “light touch regulation”) created the conditions for the many bubbles we have suffered, and for moral hazard. Better regulation, based on sustainable, long-term goals can lead to more stable, prosperous economies.
 Today, we have the unacceptable inertia of widespread agreement on the need for substantial financial market reform countered by a handwringing consensus that banks will use their political influence to block, delay and water any changes down.

The collective muscle of institutional investors could be the dynamic that tips the balance in favour of the public good. More strategic collaboration between institutions, with a strong emphasis on educating clients and lobbying decision-makers – the latter won’t work without the former – is needed.

Once this intent develops, the finer, more complicated points can then at least be fully debated. A few thought leaders in the field understand this. But real impact, I believe, requires a behavioural change for organisations like the United Nations Principles for Responsible Investment (UNPRI) and the International Corporate Governance Network (ICGN), from whom we’ve heard little or nothing through this crisis. Responsible investment and better corporate governance are weakened concepts if the broader financial system is unsustainable.

If investor responsibility can’t grapple with the big issues, what is the point of these organisations? We need 
them to step up to the plate. The US has taken something of a lead in this regard with the appointment of an Investor Advisory Committee to the Securities and Exchange Commission (SEC). It has a mandate to represent the viewpoints of investors for recommendations to the Commission. US investors should work hard to ensure its voice is heard. And the Volcker Plan – even if it doesn’t go far enough – is a good example of real action.

Elsewhere, we need more joint effort of this type to examine where regulation needs influencing, vested interests loosening and systemic blockages unplugging.
 Sceptics who argue that this is something institutional investors can’t or won’t do need only look at the recent furore over the EU Alternative Investment Fund Managers Directive to witness the power of collective lobbying. That saw institutional investors stand up alongside private equity and hedge fund lobbyists to target governments, leading to this week’s Directive postponement.
 Whatever the merits of that campaign, I would argue that the future sustainability of the financial system merits an equal, if not greater, mutual response.


The silence of pension funds on post-crisis reforms is truly discouraging. The biggest pension funds will routinely meet at ILPA meetings (Institutional Limited Partners Association) to discuss private equity investments but they rarely, if ever, discuss bolstering corporate governance or financial reforms.

I won't get into a whole discussion on what I think pension funds should be doing to bolster corporate governance. At a minimum, they should stop allowing Wall Street firms to continue paying ungodly bonuses even if they lose billions of dollars. That's just insane.

Also, watch the interview below with FT Alphaville reporter Stacy-Marie Ishmael on why without meaningful reforms, investors will inevitably get burned again on OTC derivatives. Ishmael thinks there should be a "rethink of suitability" when it comes to derivatives as well as "higher standards of disclosure."

Anyways, I am tired tonight, having just come back from Rosalie restaurant where I had dinner to raise money for WaterCan, a Canadian charity dedicated to fighting global poverty by helping the world’s poorest people gain access to clean water, basic sanitation and hygiene education. I had a great time, and thank the people from Aveda Montreal for organizing a wonderful evening.

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Dutch Pension Giant Sues Bank of America

Harry Wilson of the Telegraph reports that Dutch pension fund sues Bank of America for $100m:

Dutch Pension fund ABP, which manages $285bn, has filed a lawsuit in New York against Bank of America, accusing the financial group of hiding billions of dollars of Merrill Lynch losses, which if disclosed might have led investors to vote against the merger with Merrill Lynch.

The suit goes on to claim that Bank of America withheld details of a secret document it signed with Merrill Lynch guaranteeing the payment of up to $5.8bn of bonuses to the bank's staff.

ABP's lawyer Jay Eisenhofer, managing partner at law firm Grant & Eisnhofer, said: "Had the shareholders known all the facts, they would have been able to make a more informed judgment and possibly prevented a disastrous acquisition."

APG, ABP's in-house investment operation filed the lawsuit, and is seeking as much as $91m in damages from Bank of America. Bank of America declined to comment.

"Prior to the merger date, BofA appear to have had knowledge of record quarterly losses Merrill was facing," AGP said in a statement. "The losses were expected to exceed $15 billion."

Bank of America has also faced legal action from the US authorities.

The Securities and Exchange Commission has sued the bank twice for "misleading" investors over the bonus payments, fining it $33m in August, before announcing a second $150m settlement last month.

Andrew Cuomo, New York attorney general, has been Bank of America's most vociferous critic and has filed a civil fraud charge against the bank's former chief executive Kenneth Lewis, who oversaw the deal.

Mr Cuomo has been instrumental in bringing to light many of details surrounding the merger, including the multi-million dollar bonuses paid to some staff.

It's not just the Dutch pensions who are getting tough. On Monday, the board of California's giant public pension fund, CalPERS, voted to remove the limit on the number of shareholder proposals it can issue to companies in its portfolio:

Lifting the number of proposals its board can file each year means the fund's influence is likely to grow among publicly traded companies.

The California Public Employees Retirement System, which holds about $200 billion in investments, is the nation's largest public pension fund.

In the past, its board has pressured companies to make changes to executive compensation and to increase what it considers to be socially responsible investing.

Those challenges have resulted in corporate governance changes at companies such as The Walt Disney Co., where pressure from CalPERS helped lead to the ouster of former chief executive Michael Eisner.

Shareholder proposals usually specify a policy change that CalPERS would like a company to make. For example, CalPERS intervened last year when Eli Lilly & Co. would not allow its shareholders to call a meeting of its board of directors. The company later agreed to seek approval to eliminate its classified board structure.

Until Monday's vote, the CalPERS board was limited each year to 20 proposals related to executive compensation and 10 related to corporate governance.

The change, which takes effect immediately, allows CalPERS to submit "as many proposals as necessary to carry out CalPERS shareowner activities consistent with its fiduciary duty," Ann Simpson, senior portfolio manager, said in a statement.

The previous policy was put in place when CalPERS was criticized for taking a shotgun approach in trying to influence change on corporate boards, said Brad Pacheco, a spokesman for the pension fund.

The 13-member CalPERS board includes four state office holders, including Treasurer Bill Lockyer and Controller John Chiang.

In a related move, the board voted to ask 58 of the largest companies in its portfolio to adopt what is referred to as majority voting when selecting directors. Under current rules, a director can be elected by a single shareholder's vote if he or she is running uncontested for the post.

Moving to majority voting would enable shareholders to exert more influence on a company's leadership because more votes would be needed to win a seat.

"Majority voting is really about accountability," Pacheco said. "It gives the ability to shareholders to voice their opinion if they don't feel a director is performing."

Apple Inc., Comcast Corp. and Google Inc. are among the companies targeted by the move.

"This is not a shotgun approach," said Simpson, who leads the CalPERS Corporate Governance Program. "We expect a positive response from companies."

After watching Charlie Rose's excellent interview with Michael Lewis (click on his screen image to start video), I welcome anything positive that can come out of the corporate governance programs at large, influential pension funds.

But I'm not holding my breath, knowing full well that short-termism is alive and thriving on Wall Street, and many pension fund managers have their own set of governance issues to deal with, including a bonus culture that is out of whack for the results they're delivering. So while pension giants flex their muscle, making some headlines in the news, the truth is they have for the longest time totally abdicated their fiduciary responsibilities as shareholders. Once again, it's too little, too late.

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NJ Seeks to Skip $3 Billion Pension Payment

Terrence Dopp of Bloomberg reports in BusinessWeek that Christie Seeks to Suspend N.J. Tax Rebate, Skip Pension Payment:

New Jersey Governor Chris Christie proposed a $29.3 billion budget that would suspend property-tax rebates, skip the state’s $3 billion pension contribution and fire 1,300 workers next year.

The plan would reduce aid to schools by $820 million, towns by $446 million and higher education by $173 million. Christie, a Republican who took office Jan. 19, also called for a constitutional amendment that would limit annual growth in the state’s highest-in-the-nation property taxes to 2.5 percent.

“Today, we stop sweeping problems under the rug,” Christie, 47, said during his first budget address to a joint session of the Democrat-led Legislature in Trenton. “We will not hide our problems until another day. And we are certainly not increasing the tax burden we place upon our people.”

Christie pledged not to raise income, sales or corporate taxes to close a record $10.7 billion deficit in the budget for the fiscal year that begins July 1. His plan, which includes $28.3 billion in state spending and $1 billion in federal aid, is 9 percent lower than the budget for the current fiscal year, which ends June 30.

New Jersey will get $1.3 billion less from the U.S. government in fiscal 2011, according to Christie’s administration. The budget contains a total of $10 billion in reductions and would have swelled to as much as $38 billion without any action, Treasurer Andrew Eristoff said.

Revenue Projections

The plan counts on projected revenue rising 2.2 percent to $28.3 billion, which would be the first increase in three years. Christie also expects to receive $490 million in federal funding for a six-month extension of the Medicaid health-care program for the poor which is still being debated in Congress.

The new governor didn’t renew a business-tax increase or an income-tax surcharge on residents earning $400,000 or more, both of which make the state less competitive, his Chief of Staff Richard Bagger told reporters yesterday.

Eristoff said the budget will seek $8.8 million in “employee actions” including firings of as many as 1,300 workers after Jan. 1. Christie said last week he can’t lay off or furlough any of the 70,000 state workers before then because of a 2009 agreement his predecessor Governor Jon Corzine negotiated with unions as part of a $450 million wage freeze.

Spending Cap

Christie said he will ask lawmakers to institute an immediate 2.5 percent spending cap on state and local governments. The legislation would be used until a permanent, constitutional amendment can be approved, Bagger said.

Real-estate levies, the main source of funding for schools and local governments, averaged $7,281 last year, up from $7,045 in 2008, state data show. The levy has climbed 72 percent since 1999, when the average was $4,239.

Christie last month withheld $475 million in school aid to help close a $2.2 billion mid-year deficit. The education funding cuts in fiscal 2011’s plan would amount to as much as 5 percent of district budgets.

“All this is doing is pushing the state’s budget problems down to the local property taxpayers,” Assembly Budget Committee chair Louis Greenwald, a Cherry Hill Democrat, said in an interview yesterday. “I get the argument that the wealthiest New Jerseyans have options, but I wish they would get the message that many middle-class taxpayers don’t.”

Rebates

Bagger said the state would save $848 million by suspending the property tax rebate program this year and then giving homeowners direct credits on their bills beginning in May 2011.

Another $50 million would come from an unspecified plan to have some government functions run by private companies. Christie last week said he may privatize some state jobs in 2011 amid rising costs for employee salaries and benefits.

New Jersey would skip its full $3 billion pension payment, under Christie’s plan. The system was underfunded by $46 billion as of 2009 because of investment declines and a failure to make full contributions, according to annual financial reports.

“Our pension system must be reformed before we can or should fund a broken, out-of-control system,” Christie said.

New Jersey’s Senate last month passed bills aimed at closing the pension deficit by excluding part-time workers from the system, reducing benefits and forcing teachers to pay more for health care. The measures await Assembly approval. Christie urged lawmakers to act on the bills and said he would sign them “the moment they hit my desk.”

Christie’s budget includes $2.5 billion in payments on the state’s record debt, which grew to $33.9 billion last year from $3.9 billion in 1989. The state has the third-largest net tax- supported debt among U.S. states, according to a 2009 report by Moody’s Investors Service. Its general obligation bonds are rated Aa3 by Moody’s, its fourth-highest ranking, and AA by Standard & Poor’s, its third-highest.

And you thought Greece was the only government in dire fiscal straights. Governor Christie's budget is being heavily criticized but state costs have mushroomed out of control. You can read the budget speech to the legislature here.

On the same day the budget was being delivered, Bloomberg's Dunstan McNichol reports that N.J. May Boost Hedge Fund Deals to Guard Against Equity Losses:

New Jersey’s $67 billion pension fund may increase its hedge fund investments to protect against losses in the stock market, according to a memo prepared for a meeting later this week of the State Investment Council.

The worst economic crisis since the 1930s helped push down the fund’s annual returns to 2.47 percent over the past 10 years, from a target of 8.25 percent, according to the Investment Division’s latest monthly report.

“The objective of this plan is to continue to improve the fund’s overall diversification and to allow the division to achieve its long-term return objectives during today’s low-yield environment with less reliance on traditional public equities,” Joseph wrote in the memo. The investment council will vote on the proposal at a March 18 meeting in New Brunswick, New Jersey.

Andrew Pratt, a Treasury Department spokesman, declined to immediately comment on the memo. Orin Kramer, general partner of the New York-based hedge fund Boston Provident Partners LP and chairman of the Investment Council since 2002, declined to comment.

Beyond the proposal, the Investment Division supports an increase in the 28 percent limit on so-called alternative investments such as hedge funds, private equity and real estate, according to the memo.

‘Investment Opportunities’

“We believe the markets will present compelling investment opportunities in many sectors of the alternative investment environment and would like greater flexibility to pursue these opportunities over the long term,” Joseph wrote.

Holdings in domestic and international stocks, which now account for 47 percent of the state’s portfolio, would be reduced under the plan.

The Investment Division manages funds for the state’s seven pension funds, which provide benefits to about 800,000 working and retired teachers, police officers and government employees.

Through June 30, 2009, the pension system was underfunded by $46 billion, with the assets on hand worth less than half the cost of the benefits already promised to members, actuary reports released earlier this month show.

So Governor Christie is slashing everything in sight, even seeking to skip pension payments but the state pension fund is looking to increase its allocation to alternative investments, paying out millions in fees to the very same funds that exacerbated the financial crisis. Oh what an ironic twist!

The pension herd hasn't learned its lesson. According to Deutsche Bank, investors around the world may put as much as $222 billion into hedge funds this year. More hedge funds, more private equity, more real estate, more of anything that gives them the leverage they need to attain that unrealistic 8% long-term target return.

If investment authorities think that alternative investments are going to lead New Jersey or any other state pension fund out of their pension woes, they are deluding themselves.

Mark my words, the situation is only going to go from bad to worse. Leverage in the hands of fools is like giving an arsonist gasoline to light out a fire. Once again, the pension herd will get burned, and pensioners and taxpayers will bear the costs.

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Private Equity’s Trojan Horse of Debt?

Gretchen Morgenson of the NYT reports on Private Equity’s Trojan Horse of Debt:

Whenever savvy private equity firms sell debt in the companies they own, buyer beware.

That’s the lesson — learned the hard way — for bondholders in Wind Hellas, a Greek mobile phone operator whose parent company defaulted on some of its debt payments last November.

A once-healthy company that is Greece’s third-largest mobile phone operator, Wind Hellas was taken over in a 2005 buyout by two global private equity giants: Apax Partners out of London and the Texas Pacific Group, led by David Bonderman. The two firms larded Wind Hellas with debt before selling it off just two years after they bought it.

Wind Hellas filed for the British equivalent of bankruptcy protection last fall, and now some investors are trying to figure how such a promising enterprise went aground. Apax and T.P.G. officials declined to comment for this column.

But Bertrand des Pallières, the chief executive of SPQR Capital, a London investment firm, was one of the larger bondholders in Wind Hellas. He says the decision by Apax and T.P.G. to heap debt onto the company while simultaneously extracting so much cash from it ultimately contributed mightily to its woes.

“The private equity industry always pitches how constructive it is as an investor force to create jobs and growth,” says Mr. des Pallières. “But there are private equity funds that get rich by breaking companies and making others poor — whether they are creditors, states or employees.”

When the deal to buy Wind Hellas — then known as TIM Hellas — was struck in 2005, the buyers gave it a nifty code name: “Project Troy.” Apax and T.P.G. paid 1.1 billion euros for 81 percent of the company; later that year, they paid 264 million euros more for the rest.

At the time of the buyout, TIM Hellas was a young company with a history of operating growth, regulatory filings show. From 1999 to 2004, the year before the buyout, cash flow at TIM Hellas grew almost 17 percent, annualized. It generated cumulative earnings of 283 million euros for the years 2001 through 2004, and by the time of the deal was serving 2.3 million customers.

The company had little debt — 166 million euros — before the buyout and boasted shareholder’s equity of almost 500 million euros. Then Apax and T.P.G. came calling.

Major banks, including JPMorgan Chase, Deutsche Bank, Lehman Brothers and Merrill Lynch, financed Project Troy. Apax and T.P.G. put approximately 450 million euros into TIM Hellas as equity, but this money was returned to the firms less than a year later after the phone company issued a round of debt.

The private equity firms also received consulting fees worth 2 million euros per year, company filings show. In addition, Apax and T.P.G. received 15 million euros for “business advisory services rendered in connection with debt placement and preparation of business and strategic plans,” according to the company’s 2005 annual report.

Under its private equity owners, TIM Hellas took on debt immediately. By the end of 2005, the company was carrying 1.26 billion euros in long-term debt, almost eight times the level a year earlier. Then came the bond offering of 500 million euros in April 2006 that let Apax and T.P.G. get their money out of the company. After that deal, Standard & Poor’s cut the company’s debt rating to B, citing “the significant increase in leverage and material weakening of free cash flow.”

Still another trip to the debt markets for TIM Hellas occurred in December 2006, when it raised roughly 1.4 billion euros. By the end of that year, the company’s debt load had grown to over 3 billion euros, 20 times the level of two years earlier, before the buyout.

At the same time, the company’s financial performance was declining. Net income at the company rose from 35.9 million euros in 2001 to almost 80 million in 2004 but shifted to losses in 2005. From 2004 to 2008, the company showed losses totaling 155 million euros.

Perhaps the most interesting part of this tale involves a transaction that occurred around the time of the December 2006 debt offering. In that deal, 974 million euros — out of the 1.4 billion euros raised in the offering — went from the company to Apax and T.P.G. The prospectus for that transaction described the 974 million euro payout as a repayment of “deeply subordinated shareholder loans.”

But at the time of the offering there weren’t any such “shareholder loans” listed on the company’s balance sheet. In other words, the company was paying back Apax and T.P.G. for loans that were listed as equity rather than as debts at TIM Hellas.

Adding to the mystery, the repayment was made using a peculiar transaction involving the redemption of “convertible preferred equity certificates” that TIM Hellas had issued. These exotic securities can be accounted for as debt or equity, an option that allows companies that issue them to choose whichever category gives them the most tax advantages in a given country. TIM Hellas classified the certificates as equity.

TIM Hellas had issued such certificates when it was bought out in 2005, and as of April 2006, each certificate carried a value of 1 euro, according to the company’s filings. The company’s 33.8 million certificates outstanding as of September 2006, therefore, had a value of 33.8 million euros.

Company filings from September 2006 seemed to assure potential bondholders that TIM Hellas could redeem these certificates at prices greater than par value or market value only when “the company does not have any other debt liability to pay or to provide for with priority” to the certificates.

On Dec. 21, 2006, however, the certificates were redeemed to pay back those mysterious “shareholder loans.” And they were redeemed for 35.6 euros each, which generated the 974 million euros used to pay Apax and T.P.G.

Just 10 days later, as 2006 was drawing to a close, the value of the equity certificates fell back to 1 euro each, according to company filings.

Why did the certificates suddenly spike in value? Neither Apax nor T.P.G. would say. But their lofty price, according to the debt prospectus accompanying the transaction, was determined by a friendly crowd: the directors of one of TIM Hellas’s own subsidiaries.

These board members weren’t identified, but at the time the board of TIM Hellas itself was very clubby. It consisted of 10 people; six were employees of Apax and T.P.G., and two were company insiders. The other two directors were independent.

In February 2007, less than two months after Apax and T.P.G. snared the windfall from their certificate payout, the firms sold TIM Hellas for 3.4 billion euros in equity and debt.

Last fall, the parent company for the mobile phone operator now known as Wind Hellas defaulted on some of its debts, an unhappy situation that has left Mr. des Pallières, the investor, shaking his head.

“Private equity and banking can be very constructive functions of the economy, but they will destroy this industry if the leading players do not regulate themselves,” he says.

It’s yet another tale for our times.

I thought David Bonderman was actually one of those PE guys who created value. Guess I was wrong. The leading PE funds, and the banks that finance them, are on a rampage and they will end up cannibalizing each other and the companies they purchase as they attempt to squeeze blood out of stones.

Of course, they'll do this using your pension dollars, collecting 2 & 20 in the process of saddling these companies with as much debt as possible before they carve them up and sell them off to the highest bidders. Ironically, in the investment community, we call this "alpha".

***Comment from a senior pension fund manager***

A senior pension fund manager sent me this comment which I share with you:

So the foolish bondies, who actually underwrote a money out financing, are not to blame?? Have we all forgotten we had a credit crisis, because decisions like this by institutional fixed income people?? Private equity owners may have weakened the company, but only because fixed income people allowed it to happen, first the banks, then the bond market.

My observation is that the fixed income business, taken over by derivatives traders, has brought our system to its knees. All the rest is aftermath, and noise. It's game on in the trading area, and absolutely nothing has changed.

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Another Great Depression Coming Soon?

Mark Davis of the Kansas City Star reports, Depression is coming soon, Olathe economist predicts:

Pray that Bill Helming is wrong — again.

And to be honest, he’d be good with that. Nobody wants to live through an economic depression marked by a beaten-down stock market, a jobless rate at 12 percent, widespread debt defaults and a deflationary price spiral that takes the economy down with it.

Yet we’re on our way, says Helming, a widely respected agricultural economist who lives in Olathe. His new book, “What Goes Up Eventually Comes Down,” lays out the dismal forecast.

“I hope I’m wrong, but I’m trying to be as much of a realist as I can,” Helming said in an interview. “The stage is set for some difficult times in urban America. There’s nobody that’s going to be left out of this.”

Helming has had dark visions of tomorrow before. For example, when the stock market crashed in October 1987, Helming feared the worst.

“We’re heading for a recession we haven’t seen the likes of since the 1930s,” he told The Star at the time.

Helming saw summer 1990 as the onset of “the most serious deflationary recession we’ve had in over 50 years.”

He declared outright in November 1992 that the nation’s economy had entered a depression. And July 1994 reminded him of “what happened in the early 1930s.”

We know now he was wrong. That doesn’t keep his or others’ dire forecasts from attracting attention during hard times.

A depression remains in the economic forecasts of author Harry Dent Jr., and deflation figures strongly in the views of economist Gary Shilling and technical analyst Robert Prechter.

Gloom and doom never really goes away, as if in good times we want reminders not to overdo it. But predictions of a sharp depression are clearly outside the mainstream of economic forecasts today.

Talk of depression had rattled markets a year ago, for example, when Harvard economist Robert Barro put the odds at 20 percent. Recently, he set them “close to zero” for 2010.

Most economists expect a weak, slow recovery — but a recovery all the same.

Bubbles don’t burst

Helming makes his case for what he calls a “modern-day depression” in his 195-page, self-published book.

We’ll see a sustained drop in the prices of just about everything, from stocks and real estate to wages and commodities. Some of that is happening now.

Helming argues that much more lies ahead. He said decades of easy credit and increasingly widespread use of debt — by governments, companies and consumers — have inflated the economy and the price of nearly everything to unreasonable heights.

“We borrowed our way to prosperity, and that has never in history been sustainable,” Helming said.

In short, we’re living in an economy packed with bubbles.

But in Helming’s forecast, bubbles this big don’t burst. They deflate.

It will take years, difficult years, to deflate prices, unwind excessive debt and stabilize the overblown economy, he said. It will take a depression. Think of Japan’s lost economic decade of the 1990s, he said.

Helming is clearly right about one thing. Few Americans know what it’s like to live through a depression. And that’s one of the conditions that he says brings them on.

We’re really riding an inevitable cycle of decades-long economic booms followed by shorter but painful busts, Helming notes. The latest boom began in 1940, on the heels of the Great Depression.

We have seen 11 recessions since then, by Helming’s count, but these were merely interruptions. After each recession, the boom returned and did so typically in about a year.

We became convinced that the boom would always return because, as far as we know, it always had. Complacency brought on more debt, more spending, consumption and bubbles and, in 2008, the bust.

“It’s already playing out, but it’s going to play out much more dramatically,” he said.

Eyes of the storm

As bad as the last two years have been, Helming says the most difficult stretch starts later this year.

By 2012, unemployment will climb to 12 percent from the current 9.7 percent. Add in discouraged workers or those who are underemployed and Helming sees 32 million, or 20 percent of the work force, suffering from a lousy job market.

Houses will lose half the value they had in 2006, he said, adding that they’re already down by a third.

The Dow Jones industrial average, currently above 10,600, likely falls below 4,000 and possibly as low as 1,500 or even 500, he said. Little wonder that Helming’s advice is to dump all your stocks by the end of April.

Cash will be king, so you’d want to own federally insured bank deposits, U.S. Treasury debts, and only the best corporate bonds and annuities.

Get a good alarm system, too. Helming notes that many families at least fed themselves during the Great Depression because they lived on farms. We’re mostly urban now, and he expects riots.

Though falling prices may sound good to consumers, persistently falling prices can be bad for the economy.

The pain is worst for those who owe a lot of debt. But as their burden becomes too great, the pain spreads to those owed the money because they won’t be getting it back.

For example, falling home prices and foreclosures have hurt homeowners and lenders alike. Helming’s forecast sees that happening with debts of all kinds, public and private.

Where’s the proof?

For all its numbers and graphs, Helming’s book is short on proof that he is right this time.

He offered three reasons his earlier predictions fizzled.

World trade grew more than he’d expected.

The technological boom created jobs he hadn’t counted on.

He also hadn’t appreciated the impact that baby boomers would have on the economy as they reached a spending peak in the 1990s and 2000s.

“That’s something that clearly bought more time,” Helming said.

Many other economists say government support of credit markets avoided a depression. Others say debt’s burden can be dealt with gradually by saving more as a nation without wrecking the economy.

Those who don’t expect a severe depression have the same problem Helming faces.

They can’t prove we won’t have one.

Before you go out to purchase an alarm, guns, ammunition, or some razors to slice your wrists in light of Bill Helming's dire warnings, the world isn't half as bad as he thinks.

Importantly, world trade has drastically improved since 2008. The latest figures from the Netherlands Bureau of Economic Policy Analysis showed that world trade volume expanded by an unprecedented 4.8% in December 2009 from the previous month, and in the fourth quarter of 2009, world trade was up by 6.0% from the third. That is a new high in the series of trade momentum, which starts in 1991.

But the debt overhang in the US and other developed nations is what concerns many economists and ordinary citizens. This is especially true when you factor in future pension obligations. Then the real debt crisis seems enormously crippling.

However, there is some good news worth noting on the non-governmental debt burden. Marc Pinsonneault, economist at the National Bank of Canada recently wrote about how US nonfinancial debt growth lowest ever:

To financial markets, massive U.S. federal deficits and consequent debt piling is a concern. As today’s Hot Chart shows (click on image below), it might be reassuring to know that despite an annualized 12.6% increase in federal debt in Q4, domestic nonfinancial debt rose 1.6%, the lowest growth rate since at least 1952. This growth rate does not exceed CPI core inflation, a rare occurrence outside inflation spikes. This slowdown in domestic nonfinancial debt growth is due to the deleveraging that is taking place in both the household sector, and the business sector. In the latter case, debt has decreased in each of the last three quarters, the first such sequence since the beginning of the 1990s, when businesses struggled with a record indebtedness in a recession period. The combined debt of businesses and households declined an annualized 2.4% in Q4, the biggest drop on record.

While there are many economists who still see a double-dip in the cards, including Chris Thornberg of Beacon Economics, others are cautiously optimistic, saying we have escaped the worst case scenario.

My own thoughts on this is that we have escaped the worst case scenario, but we are in for a long, tough slug ahead. The forces of deflation and inflation are playing themselves out, leaving financial markets wishy-washy. I still think stocks are the best asset class and that corporate spreads will come in further in 2010, but my buddy who trades currencies is right, this is a great environment to be selling volatility.

I am, however, less enthusiastic on private markets, especially commercial real estate which is the next bubble to burst, hammering many banks in the process. And it's not just banks. Many pension funds invested enormous sums in commercial real estate through direct equity stakes and mezzanine real estate debt. They too are going to get hammered.

So while I am cautiously optimistic and try to focus on the little good news percolating up from the global recovery, there are still many significant challenges that lie ahead. Is another Great Depression headed our way? Let's all pray and Bill Helming is wrong — again.

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