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November 20th, 2009

The Fear Of All Sums Would Be An Apt Title For a Tome Outlining The Condition Of State And Municipal Pension Plans.

The Fear of All Sums would be an apt title for a tome outlining the condition of state and municipal pension plans. A sequel would similarly describe the financial condition of the states and municipalities themselves. During the past few months the states of: Washington, California, Arizona, Michigan and Georgia have laid off or furloughed 98,000 employees. Rhode Island has furlough plans for 81% of the state’s employees for twelve days. California issued IOU’s instead of income tax refunds. A total of seventeen states have implemented furloughs. Rising payroll and benefit obligations coupled with large mandatory pension contributions have placed these governments in crisis mode. Political and practical reasons have kept them from making necessary choices on headcount, work rules and benefit levels, but the few recent bankruptcies we have seen may be showing the path.

The pension predicament is equally stark. Before the financial collapse of last Fall many were already under-funded, some by as much as fifty percent. The declared funding levels are dubious as many funds were assuming per annum returns of 8%, an optimistic assumption at best. Mergers of some of these plans to save costs will help, but the real money is in benefit reduction and retirement age changes. The political will to make these choices is not evident, but financial obligations may force their hands.

What do either of these trends bode for private equity? Certainly the pursuit of “higher returns” will keep funds interested in the asset class until someone points out the Emperor’s new clothes have not delivered as promised. More likely some municipal services will be outsourced to the private sector as a way to reduce current costs and pension expenses. According to the Financial Times, a civil servant college graduate who works forty years will retire with a pension valued at 2 1/2 times the pension of a similarly skilled private worker who worked the same time frame. Despite the usual deficit in current wages paid to civil servants, their pension costs change the calculus. Additionally, recent data suggest the gap between civil and private wages for similar work is approaching nil. Financing the growth of this outsourcing, if it occurs, could be an attractive opportunity for PE.

Left to its own devices, CitiGroup normally finds ways to astonish us with its decisions. Now, led by the wisdom of its new PE investor, the federal government, who seems not interested in protecting other shareholders’ interests, its own interest nor creditors’ interests, CitiGroup has embarked on a divestment strategy advised by Rube Goldberg. The most consistently profitable unit of Citicorp was Phibro, with earnings averaging over $450 MM per year. The fellow who ran it was paid an extremely large amount of money, $100 MM in good years. The government felt no one under its umbrella should be paid so richly. Rather than quietly divest their most profitable business to logical suitors the compensation discussion was instead allowed to dominate the front pages making the sale forced. Per Steve Chazen, President of Occidental, the buyer; “Why pay CitiGroup a premium?” What leverage do the sellers have?” At a normalized bank PE multiple of ten the market capitalized Phibro at $4.5 Billion or $4.1 Billion more than Citi received for it after their PE owner helped the process! Finally, when you had suspended disbelief, the government asked the CitiGroup Board, the poster child for failed boards, to evaluate CitiGroup executives. They performed the evaluation by interviewing CitiGroup senior executives and directors about their impressions of the Pandito and other senior executives. It feels like a Cuban election.

As Toyota emerges as the winner in the U.S. “Cash for Clunkers” program, we turn to our elected officials for more quiet wisdom. The decline of civility in political discourse, the most glowing symbol of recent vintage, is led by Rep. Wilson and his “you lie” accusation during President Obama’s speech. Following closely behind is Governor Schwarzenegger’s, Davinci Code-like profane acrostic in his recent note to Assemblyman Ammiano, who had called the Governor “a liar”. Hopefully, we do not regress to the 1856 U.S. Senate level when Senator Charles Sumner referred to Stephen Douglas as a “Noisesome, squat animal” and mocked Andrew Butler for his mistress and for his manner of speech. The next day Butler and Laurence Keitt beat Sumner on the skull with a gold plated walking stick until Sumner was unconscious.

My Dinner with FASB – The hobgoblin of little minds in the last few years has been the notion of fair value. The S&P 500 has risen over 60% in value since March 9th of this year, yet any value determined on a registered exchange is deemed by FASB to be as unrequiring of support as a summer cloud. Despite the obvious caprice that goes into the end of day stock prices, which is more likely to be determined by a two martini lunch at Harry’s Bar at Hanover Square than any analytics, the accounting arbiters have deemed that private market assets need to be determined with a false precision akin to measuring beauty. FASB, which is now ASC on its way to becoming IASB, has added new dimensions to its quest for documentation of opinion, tied, of course, to 12-31-09 public stock prices which have “only” varied in a 60% range in the past eight months. Despite all of the wasted time, effort and money, the results will be the same. Different investors in the same security will have widely different results. The actual results will not change any actual economics in any sensibly written partnerships. Millions of dollars will be spent on producing the “documentation”, none of which will actually improve any investment nor make it saleable at that value. Pacioli can declare his work here is done.

We have been notified by Stockholm that, although it seems early, we have been named the recipient of the 2010 Nobel Prize for Private Equity based on our marketing materials.

I’m Rob Morris and I approved this blog.

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