Calpers, Placement Agents, and Corruption?

Bloomberg reports that Calpers and Blackstone are having a slight difference of opinion over whether money managers should be allowed to pay contingency fees to "placement agents." Placement agents work for private equity, hedge funds, venture capital and real estate firms, typically earning a the equivalent of 0.5% to 3% of the money they place under the management of their client. Calpers is introducing legislation requiring placement agents to register as lobbyists and ending what Bloomberg calls "pay-for-success" arrangements and I call "pay-for-doing-nothing." Apparently, Blackstone is not happy about abolishing the practice, as it has likely benefitted enormously from the bribing, er, paying of enormous fees to win huge chunks of Calpers money to manage over the years. Besides, there's nothing corrupt about paying $59 million in fees to a former Calpers board member for doing all of that hard work of calling his old pals at Calpers and asking them to part with large chunks of $209 billion in retirement assets so he can get paid. I'm sure that required like at least a five minute phone conversation:

Placement agent: Hello Harry? This is Charles!

Calpers Money Manager: Hey Charles, you old goat! How ya doing?

P A: Wanna go grab beers today?

Calpers guy: Nah, the wife'll get all mad.

P A: Ok, we'll do it some other time. By the way, any interest in our new private equity fund? It's the biggest fund we've ever raised. We're preparing to do a $100 billion takeover. You know, lever it up and then flip it via IPO. Works every time.

Calpers guy: Oh, great idea! Here's $1 billion.

PA: How about our new real estate..

Calpers guy: Oh definitely. Here's another billion. I gotta hop. It's 5:05 PM, gotta head home.

So yeah, that conversation was worth $59 million in retiree money. I'm sure all those funds are performing swimmingly too.

Calpers Considers Cutting Rate of Return Target

Calpers is considering taking some drastic action on the heels of the bruising 23% decline its investments posted for its last fiscal year ended June 30th. The mammoth pension fund that manages approximately $200 billion in assets for California's pensioners is contemplating reducing its current projected rate of return from 7.75% to maybe something with a six handle. You see, it was time to take some decisive action. What could be more effective than tweaking an imaginary number and using that as a basis for all future investment decisions?

I totally understand the decision. I did the same thing with my own investments. In fact, I just resolved my looming retirement fund issues by raising my return "target" from 8% to 35%. Now I should have no problem retiring with a cool $100 million in the bank. Problem solved.

A logical person might ask why Calpers chose to lower its imaginary rate of return number instead of raising it to plug the hole in its future obligations? Imaginary (and scary) as it might be, the percentage is an important factor in calculations by Calpers officials of future contributions needed from employees and local governments to cover payouts promised to retirees and other beneficiaries. If return assumptions decline, contributions have to rise. Uh yeah, because California has so much extra money lying around that it's going to be thrilled to increase its contributions to the pension fund that pissed away retiree assets while making private equity and real estate investment fund managers rich. In case the folks at Calpers haven't been keeping up with current events, California is mired is some pretty serious budget poop. This is not exactly the right time to go hat in hand to the state and local governments.

Additionally, the pension fund believes that lowering the rate of return would "reduce the temptation" to seek outsize profits through real-estate, private equity and other alternative investments. This decision would've been brilliant had it been made like three years ago. Now? Maybe not so smart. In any event, the final decision isn't expected until early 2011. So they have another year or so to debate whether the right number is 6%, 6.1%? How about 6.5%?

Fallout From Financial Crisis Widespread

This morning's WSJ is a veritable cornucopia of articles detailing the lingering effects of the financial crisis. First, the reader is hit in the face with the headline story "Lending Falls at Epic Pace" and the accompanying graph that depicts, well, lending falling at an epic pace. Aside from the top-tier banks, most of which are making money from trading rather than lending, the rest of the banking industry is suffering, according to the FDIC's quarterly report. Banks registered their biggest full-year decline in total loans outstanding in 67 years. Also, the FDIC's problem bank (those at risk of failing) list grew to 702. Furthermore, more than 5% of all loans were at least three months past due, the highest level recorded in the 26 years the data have been collected.

Moving right along to some dismal local news for those of us in California, there is the story entitled "Lehman's Ghost Haunts California," which tells the sad tale of the aftermath of San Mateo County's failed investment in Lehman Brothers. That $155 million the county punted on Lehman bonds (commercial paper? whatever it was, the risk premium was definitely not justified) is looking pretty foolish now that the public schools are laying off teachers, community colleges are scrapping new facilities and the commuter rail is trimming service.

Speaking of California and really bad investment decisions, you can read all about Calpers latest woes in "Backlash Hits Calpers Property Deals." The story details the controversy surrounding some of Calpers' real estate deals which, in addition to losing buckets of money for California retirees, also had the socially conscious benefit of evicting low income residents from their housing units. Calpers response? "These historical investments were made under previous investment leaders" and outside managers who handle Calpers real-estate investments. Translation? If you're looking for someone to nail to the stake, you might want to go after, um, the other guys who were here. Back in early 2008 when most of Calpers' senior investment managers left for "personal reasons," it turns out those reasons weren't so personal after all. Who could've guessed? Oh yeah, me.

Moving right along, there is the article on yesterday's unexpected plunge in consumer confidence entitled "Jittery Shoppers Dim Stores' Hopes." It turns out that unemployed people don't shop so much. Shocking.

Even Casket Makers are hitting tough times, according to the cleverly titled "Casket Makers Dig In as Sales Take Hit." In addition to discussing how the economic slump is hurting the casket making industry, the article also sports the Pulitzer-worthy opening line of: "As their sales slow, some casket makers worry their business is hitting a dead end."

Looking for some good news amid the gloom? Look no further than "Bon Appetit: Toxic Bonus Yields 72% at Credit Suisse," which tells the tale of the 2000 investment bankers forced to take some of their bonuses in 2009 in the form of toxic assets. The assets have since rallied 72%, although employees can't withdraw from the plan until 2014. According to the story, the bankers groused about the plan when it was first introduced and they are probably still grousing that they only get to collect interest payments until the plan's expiration in four years.

You can read all about Wall Street bonuses rebounding in 2009 in "Wall Street Bonuses Get 17% Bounce." Then again, unless you work on Wall Street, maybe you'd better not.

More From the Property Report

A couple more highlights from the WSJ Property Report this morning:

Calpers has given up control of its stake in a trophy office tower in Portland, Ore. The Koin Center, nicknamed the "mechanical pencil" for its signature shape, was purchased for $109 million in 2007 by a partnership that included Calpers and CommonWealth Partners, a real-estate investment company based in LA. The partnership has defaulted on the $70 million debt, and New York Life, the lender, has appointed a receiver to control and possibly sell the property. The article has a great quote from a senior vice president of corporate services for Colliers in Portland "Calpers is the gold standard, and its surprising that their backup plan is to walk away." I wonder why that is so surprising since it appears to be Calpers' least expensive option. That's sort of the whole point of an option. I might have paid $1 for the Microsoft $50 calls, but since the stock is only trading a $23, I'd be an idiot to exercise them. The building's office vacancy rate is set to rise from about 7.9% in the second quarter to the 26% range by about October. I'm sure that California retirees are cheering Calpers decision to walk away from this turkey.

Stockbridge Real Estate Funds is considering a takeover bid for the management of a $2.6 billion fund run by Deutsche Bank's real estate investment unit. Apparently, this is a rare move in the real estate world. In this instance, however, some of Stockbridge's top executives are intimately familiar with the 92 investments in the fund because they used to work there and manage the fund. The former managers of the Deutsche fund bolted in 2007 when their five-year retention pay plans ended and were hired by Stockbridge. They did such a great job managing the fund at Deutsche that the fund has warned investors that it may seek bankruptcy protection. Safe from their new perch at Stockbridge, the former managers would like to buy back the crap that they left behind at Deutsche. Isn't it fun doing this with other people's money? As long as you get a nice retention package to pay you for all your talent, who really cares about the consequences when you saddle your former investors with a bunch of really crappy real estate investments?

Meanwhile, the "Technically Speaking" section of the WSJ has a ridiculously bullish piece on REITs. It explains why REIT stocks are going to continue to rise despite the many, many problems in the commercial property market. The article gives such solid evidence as "Because the sector's heavy debt load was such a big contributor to its precipitous drop last fall, REIT stocks are expected to go nowhere but up if debt refinancings occur." Also "Given the appearance that the banking system has stabilized, that leads you to the belief that most of these REITs will be able to get their refinancing in order." And my favorite "From a technical view, REITs look set to rise as much as 35% from current levels." I don't know about you, but I'm convinced. Forget everything I said in the past two posts about commercial property values plummeting, "gold standard" investors walking away from their investments and saddling lenders with half empty buildings, defaults, declining cash flows and covenant violations. I'd better go load up on some REIT stocks!

Souring Stuyvesant Property Investment Portends More CMBS Pain Ahead

Back in late 2006, when commercial property investors liked to swing it around, Tishman Speyer, in cahoots with Blackrock and Calpers, paid $5.4 billion for a huge block of apartment buildings in Manhattan.  Known as Peter Cooper Village and Stuyvesant Town, the complex of 11,200 apartments was originally built for veterans returning from World War II.  It was rumored to have turned into a great place to take advantage of rent-stabilization in Manhattan if your grandparents happened to keep their apartment after moving on to a nicer house.  Tishman Speyer's plan was to force out those who were illegally paying below-market rents, renovate, refurbish and rent out the properties at much higher prices.  Metlife, who sold the properties in 2006 was probably just looking to lighten its real estate load in what it perceived as an inflated Manhattan property market.  The insurer dumped its own monikered Metlife Building in 2005, also to the overeager Tishman Speyer.  When the Stuyvesant deal was originally announced, many commercial real estate investors marveled at the price, which implied a 2.5% cap rate (i.e. crazy).  I speculate that the shrewd negotiations between Tishman and Metlife may have gone like this:

Metlife: We have another property to show you.  How do you feel about Stuyvesant Town?

Tishman:  Love it!  How about $4.5 billion?

Metlife:  Seriously???

Tishman: Ok.  We'll pay $5 billion.

Metlife:  Now stop that!

Tishman:  $5.4 billion, but that's our final offer.

Metlife: Ok!  Ok!  You're done.  Just stop raising your bid for the love of God!

The Wall Street Journal reports today that the apartment complex is running behind its financial plan and will run out of money to pay its $3 billion mortgage in six months, according to a report released by Fitch Ratings.  As of January 15th, the project's interest reserve was $127.7 million down from $400 million when the property was purchased.  A separate general reserve fund used to renovate apartments is "completely depleted."  The private company has said in the past that it expected to fund more capital as needed.  But Tishman declined to comment.  Admittedly, it seems hard to imagine that Tishman, Blackrock, and Calpers would choose to allow the partnership to default and let the lenders seize the buildings.  But times are tight so it is a risk.  Injecting further money into this venture would be politically difficult for Calpers in particular, as its investment fund is suffering from major losses and it faces the near certainty of having to hike rates for California public employees.  Imagine having to pay more into your retirement fund because the boobs managing the money happened to invest in a bunch of illiquid land deals, soured private equity funds, and a HUGE apartment building in Manhattan? 

In any event, the situation is coming to a head within the next few months.  For the market's sake, I certainly hope that we're not looking at a foreclosure auction of 11,200 Manhattan apartments.  Frankly, I'm not sure who on earth would be interested in bidding on this beast of a property and where they would find financing in this market.  Maybe give Ben Bernanke a call?     

Calpers Down 20%, Plans to Hike Contributions

The Wall Street Journal is reporting that the California Public Employees' Retirement System has seen a decline of more than 20% in its assets.  The nation's largest public pension fund may begin to ask for an increase in employer contributions to the fund of 2% to 4% starting in July 2010 and July 2011.  Back in April, I noted that it was highly suspicious that three top money managers at Calpers had left the fund within days of each other.  Media reports claimed their departures were related to boardroom disagreements, while I speculated that it was more likely due to poor performance of the fund, as Calpers had a tendency to invest in alternative assets (such as land deals with homebuilders.)  Needless to say, it seems clear now that the managers who left Calpers in April did so to avoid having to face the music when angry California employees need someone to blame for losing their retirement funds.

On the bright side, angry California employees are probably much better off than anyone who hoped to have a pension in Argentina.  Argentina's government seized the private pension system in order to "protect investors from losses."  The surprise move caused the markets in Argentina to plummet 15%, thereby causing losses for investors.  According to the Wall Street Journal story, "While no one knows for sure what the government would do with the private system, economists said nationalization would let the government raid new pension contributions to cover short-term debts due in coming years."  So the government has seized private retirement assets to pay the public debt.  Now that is depressing.  Argentina, can we cry for you now? 

Calpers Takes Hit on Land Deal With Lennar and Cerberus

Calpers' investment in a venture called LandSource Communities Development appears to be souring. The deal was a joint venture with the beleaguered homebuilder Lennar, and LNR Property Corp, a unit of Cerberus Capital Management. These joint ventures were extremely popular during the housing boom, which allowed homebuilders to invest in land without having to keep it as an asset on their balance sheets. The property in this particular JV was north of downtown Los Angeles, once a booming mecca of future development opportunities, now a poster child of the bust. When Calpers originally invested in the vehicle in February 2007, the venture was appraised at $2.6 billion. The venture had assets valued at $1.8 billion as of the end of February 2008 and debt of about $1.24 billion. LandSource is facing problems with its debtholders and may need to file for bankruptcy soon. Lennar and LNR (the unit of Cerberus) reduced their stakes in the venture in February 2007 by coaxing a 68% investment out of the Calpers' vehicle MW Housing, which is managed by MacFarlane Partners. MacFarlane Partners, incidentally, posted a 53% loss for the year ended September 30, 2007, which was over six months ago. Even my ten month old, who spends most of her day soiling her diapers, knows that real estate valuations have declined since September 30, 2007. Although Lennar and LNR did a good job of punting a large portion of their ownership stakes close to the high, each retain a 16% stake, which could prove to be very expensive.

The Wall Street Journal claims that insiders insist that the soured land deal is not related to the resignation of two of Calpers' most senior executives this week. However, you can bet that their departure is related to what will more than likely be lousy performance numbers from Calpers this fiscal year which will close June 2008. As I stated recently in my story about Calpers, too many highly ranked executives are leaving the firm at the same time for it to be a coincidence. As for Lennar, it is the homebuilder who more than likely has the most exposure to off-balance sheet joint ventures. And Cerebrus? Those who read my blog frequently know that Cerberus pops up all the time in stories related to soured private equity deals. These guys seem to be the kings of mega-bucks blowouts. Add this one to the list. In summary, I reckon this won't be the only story about soured land deals we'll be reading about before the end of the year.

CALPERS' Chiefs' Resignations Ignite Suspicion

Just days after Russell Reed announced his departure from the post of Chief Investment Officer of the California Public Employees' Retirement System, Fred Buenrostro, the CEO, followed suit. Two months ago, Christianna Wood, Senior Investment Officer of Global Equities resigned. All of the above claim to be pursuing greener pastures in the private investing community. It is undoubtably true that they will be paid far more for their services in the private sector, but I have to wonder if their concurrent departures were somehow linked to CALPERS' investment performance. CALPERS put up very nice performance numbers through the last fiscal year, which ended June 2007. Unfortunately, we have no numbers since then and June 2007 was right before the credit markets began to melt-down causing losses to reverberate through nearly every single asset class. CALPERS is a noted investor in alternative investments, so I have to wonder how much performance has been dinged by the turmoil in the markets since June 2007. With only two months to go before the next fiscal year end, if I had to report lousy investing performance to a bunch of angry state employees who are depending on me for their retirement incomes, I'd be going where the grass is greener too.