Where is the San Diego mayor during this fiasco?

Jim Hamilton, one of the smart economists, scorches a California municipal pension fund for a bonehead strategy. Read the blurb and have a feeling of Big Whoops this will end badly for Sane Diego taxpayers. Kevin Faulconer, the mayor, will lose his job when this crashes.

The unfunded liabilities of the San Diego County Employees Retirement Association have increased every year for the last five years, reaching $2.45 billion last year, more than quintuple the level in 2008. The calculation of how big the shortfall is assumes that the fund is going to be able to earn a 7.75% return on its investment after subtracting administrative costs. If it earns less than 7.75%, the shortfall will be even bigger. A 10-year Treasury bond currently pays 2.4%, and a typical stock has a dividend yield under 2%. So what do you do if you’re in charge of the system’s $10 billion in assets?

One thing you could do is ask the taxpayers for more money right now.

What the SDCERA board did instead was to approve a strategy that is supposed to increase the return on the fund’s assets.
And how do you do that, exactly? Suppose you invest $50,000 outright in the S&P 500. If the market goes up 1%, next year it will be worth $50,500, and you’ve earned 1% on your investment. (I’m going to ignore the role of dividends, which complicate a little the calculations I’m about to describe, but don’t change the basic story.)
Or you could use your $50,000 to cover the initial margin requirements for a couple of S&P 500 futures contracts, which would have a notional value of around a million dollars. That means that if the market goes up 1%, the notional value goes up to $1.01 million, and you get to keep all the $10,000 gain for yourself. That’s a 20% return on your initial $50,000 investment– not bad money in a ho-hum market!
Unfortunately, the downside is that if the market goes down 1% rather than up, you lose 20% on your investment. Oh well, what’s life without a little excitement?