More than three years before the current financial crisis, in a series Greenspan, the Wizard of Bubbleland that began on September 14, 2005, I warned: 

“Through mortgage-backed securitization, banks now are mere loan intermediaries that assume no long-term risk on the risky loans they make, which are sold as securitized debt of unbundled levels of risk to institutional investors with varying risk appetite commensurate with their varying need for higher returns. But who are institutional investors? They are mostly pension funds that manage the money the US working public depends on for retirement. In other words, the aggregate retirement assets of the working public are exposed to the risk of the same working public defaulting on their house mortgages. 
When a homeowner loses his or her home through default of its mortgage, the homeowner will also lose his or her retirement nest egg invested in the securitized mortgage pool, while the banks stay technically solvent. That is the hidden network of linked financial landmines in a housing bubble financed by mortgage-backed securitization to which no one is paying attention. The bursting of the housing bubble will act as a detonator for a massive pension crisis.”

Now, in October 2008, while the US government is busy bailing out wayward banks, public pension funds operated by states and municipalities face their worst year of losses in history, exacerbating cumulative funding shortfalls of past decades of credit bubbles and putting pressure on distressed state governments to shore them up to avoid pending default. 

In the nine months to the end of September, the average state and municipal pension fund lost 14.8% of its market value. The loss has deepened as global financial markets fell sharply in October. The loss has more than doubled the previous highest loss for state funds, which registered 7.9% for the full year in 2002. Few market analysts expect equity prices to bottom any time soon, let alone a recovery, and many are resigned to the prospect of years of asset deflation and economic stagnation. 

California's Calpers, the biggest public pension fund in the US, in the week ending October 24, reported a loss of 20% of its asset value, or more than $40 billion, in the quarter between July 1 and October 20, 2008. State and local pension funds comprise a patchwork of 2,700 funds that manage $1.4 trillion on behalf of 21 million public employees, including teachers, firefighters, policemen and other municipal workers. About 40% of these funds are under-funded, meaning that they would not be able to pay the future pensions promised to public employees. 

State governments have raised pension benefits to keep up with inflation, betting on a growing wealth effect from fund investments to meet higher payments. It was part of the flawed rationale that called for the privatization of social security. 

Just like the social security trust fund, pension funds are money that belongs to the workers who are required to contribute into them out of their payroll deductions, matched by public funds as part of workers’ employment benefits. These funds are not charity payments from government employers. They are compulsory savings of public sector workers. 

Richard Daley, mayor of Chicago, the home town of Democratic presidential candidate Senator Barack Obama, has convened a taskforce to address the shortfalls in Illinois funds. For example, funding for the Police Fund has fallen to less than 50% of requirement. The situation is actually more ominous. The calculation is based on an assumption of annual returns of 8%, but very few funds will reach that level of return in the next few years. Most funds will be lucky to escape further losses in the current market meltdown. 

The city of Chicago would have to start contributing substantially more to the fund out of its general revenue and from federal and state subsidies. Public employees are faced with the prospect of being required to contribute more from their payroll deductions. Chicago is not unique in its public pension problem. Every city and state of the union is in similar difficulty. 

A vicious downward cycle is emerging as state and local governments face lower tax revenue that puts pressure to cut costs. Congress is pushing for a second fiscal stimulus package, in part to alleviate pressures on state pension funding. Nancy Pelosi, speaker of the House of Representatives, cited money lost from pension funds in her push for an additional $150 billion second stimulus package. 

The public pension funds themselves have limited options. Many are under pressure to move away from the stock market into less risky investments, but that would mean suffering more capital loss in this market environment and reducing returns in the future. 

Why are hard-working public employees having to pay more to make up the losses in their pension funds managed by irresponsible professionals who were supposed to protect their hard-earned capital when the bankers whose greed was responsible for the financial tsunami that caused the losses are awarded obscene golden parachutes? Because, according to Republican candidates Senator John McCain and governor Sarah Palin, "Joe the Plumber" thinks that forcing rich bankers to pay for the losses they engineered and put on the backs of public workers would be to practice "socialism''. 

Henry C K Liu is chairman of a New York-based private investment group.