This month’s Vanity Fair is almost wholly devoted to financial stories and, man, is it good. One of my favorite writers on the planet, Michael Lewis (no relation to Scott Michael Lewis, i.e. me) has this fascinating narrative on what happened in Iceland, which “instantly became the only nation on earth that Americans could point to and say, ‘Well, at least we didn’t do that.’”

But most interesting to locals is this story on hedge funds and “why hedge funds are imploding by the thousands…”

Obviously, the story is interesting from the perspective of San Diego County’s pension fund, which has something less than a billion dollars now invested in hedge funds. But the story also helps explain one of the attributes of these hedge funds that has apparently caused some alarm among those who oversee the county’s retirement system.

You might remember that when the trustees of the pension fund accepted the resignation of their chief investment officer, David Deutsch, they also talked about their potential losses in the hedge fund WG Trading. WG Trading, of course, is under scrutiny from federal prosecutors who accuse its principals of fraud. And San Diego asked for its $78 million back from the fund late last year.

But they can’t get the money back for several more months. Why?

From Seth Hettena’s story (emphasis mine):

The pension terminated its relationship with WG Trading on Dec. 31 after the hedge fund refused to cooperate with an SDCERA consultant. Under its agreement with WG Trading, SDCERA is not entitled to receive its money until June 30.

Such restrictions on hedge fund redemptions, known as gates, have caught many investors by surprise, including SDCERA. Board member Dianne Jacob, chair of the County Board of Supervisors, requested a review of all similar restrictions SDCERA might face with other investments.

Take note of that word: “gates.”

Vanity Fair helps illuminate Jacob’s worry about hedge fund gates:

There are many managers who argue that the industry’s problems are at least in part of its own making. Says Leon Cooperman, who founded the $3 billion hedge fund Omega Advisors in 1991, after a 25-year career at Goldman Sachs, “Hedge funds have shot themselves in the foot. They have not treated investors correctly.” Atop his list of sins: refusing to allow investors to take their money out, which is known in the industry as “gating” investors.

The author explains more about gating later in the story, which focuses on Fortress Investment Group, a hedge fund that evolved into a publicly traded company.

Managers who employ gates defend the practice on the grounds that it’s within their legal rights, and that selling their positions to meet redemption requests would be unfair to those investors who wanted to stay. But the widespread impression among investors is that managers broke a social contract and are doing it to save their own skins. And there may be another reason for the gates. Fortress’s documents, for instance, disclose that “our funds have various agreements that create debt or debt-like obligations … with a material number of counterparties. Such agreements in many instances contain covenants or ‘triggers’ that require our funds to maintain specified amounts of assets under management.”

In other words, gates may mean that the money invested in a hedge fund simply isn’t accessible — or worse, that the assets simply don’t exist:

Others in the industry also say that preventing investors from taking their money out is nothing short of an admission that the assets in the fund can’t be sold as they are currently valued.

So, like the county supervisor, we should all be interested in how many gates the county pension fund’s money is locked behind. If there are many, there may be little reason to be confident that how much money the fund says it has is truly how much money it does have.

And the number of assets the county pension fund actually owns has never been as big of a deal as it is now. Craig Gustafson at the Union-Tribune, with a pretty comprehensive news story, got Jacob on the record this weekend saying she and the board are now going to try to return to something close to the pension benefits level they abandoned in 2002.

In the piece, Jacob expressed even more alarm than she has about where things are headed with the fund and confesses that the board of supervisors should not have given the benefit enhancements it did that year.

The benefits Jacob speaks of are the ones she and her fellow supervisors approved in 2002 for all county employees, including themselves. The county can’t change those promised benefits for 35,000 current and former employees, but it can for new employees.

“Based on what the board knew in 2002, it was a good decision,” Jacob said. “Based on what we know today, it is not.”

This is tortuous. While I give her credit for coming close to admitting it was a mistake (though her colleague, Greg Cox, came much closer almost four years ago), she’s still trying to rationalize the fiscal atrocity that was the 2002 enhancement of county pension benefits. It is never, ever, on any planet, in any solar system, in any galaxy, and in any economy a “good decision” to give employees a 50-percent boost to their expected benefits and then have it apply retroactively to all their thousands of years of service without even trying to identify from where the massive amounts of new revenue that will be needed to pay for this are going to come.

Yet Jacob and her colleagues did it blithely and then had the chutzpah to crow about how fiscally responsible they were compared to other local municipalities.

Now they want to turn back the clock. Good luck with that. Even if Jacob and her colleagues are successful in putting new hires onto yet another new pension formula (are we just going to do this every few years?) it will be a paltry savings that won’t bear real fruit for several more years. Jacob and the other supervisors and the thousands of county employees lucky enough to have showered themselves in the benefits of this “good decision” from 2002, will never have to worry about losing their benefits.

Meanwhile, the already controversial level of services the county provides its citizens will suffer further as the county is forced to put as much money into its pension fund as it costs to run the entire sheriff’s department and District Attorney’s Office.

So this helps put the risk of these hedge funds into context. The last thing the county needs is to lose tens of millions more in the market. Its ill-advised venture into the most risky of investments imaginable might worry you more knowing just how far down the fund is compared to the benefits its promised. But not nearly as much as you should be when you also consider that this economic situation we’re in might be one for the history books and revenues to the county could plummet even further.

Yes, seven years ago, had the supervisors been truly “conservative” and had they declined to give this extraordinary enhancement, they would have hundreds of millions available to deal with this economic calamity. They could have given their employees some basic salary raises. They could have truly been long-term thinkers. But the supervisors thought it was a good decision to do this instead. How nice for us that they’re all still here to make the good decisions now.

SCOTT LEWIS

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