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Alexandra Harris/Medill

Illinois Rep. Kevin Joyce introduced a bill that would ban pension funds from investing in OTC derivatives. However, Wall Street and state pension fund lobbyists killed the bill in March.

State lawmaker seeks change in Illinois pension law

by Alexandra Harris
June 10, 2010

Kevin Joyce, Illinois state representative for the 35th district in Chicago’s Southwest suburbs, will be the first to tell you he’s no derivatives expert, nor a financial one for that matter.

But the current high school football coach whose work experience has been in waste management had talked to enough financial experts to know that OTC derivatives were threatening Illinois’ grossly underfunded pension funds.

“Pension funds stay invested in these derivatives and after other investors pull out, pension funds are left holding the bag,” Joyce said. “At the end of the day, pension funds are taxpayer dollars.

“They’re better off taking money and putting it underneath their mattresses than what they were doing for the last five years,” he added.

In early 2010, Joyce wanted to end what he saw as excessive speculation in Illinois’ pension funds and retirement systems. He introduced HB5095, which would ban pensions and retirement systems from investing in any funds that “trade derivatives in off-markets or non-open markets.”

While the notion of pension funds investing in OTC derivatives is unsettling, the short-term impact of the passage of HB5095 is also worrisome, said Rosenthal. In that case, the state’s pension funds would have to close out any OTC derivatives positions held in their portfolios.

Rosenthal said the idea of multiple funds simultaneously closing positions is troubling in markets that are so illiquid that counterparties can get stuck.

“Finding someone to take over these positions is hard. You have to get two people to agree to let them cancel,” he said. “When I was at Long Term Capital Management, flattening OTC derivatives contracts took months because they had to develop special tools for them.”

HB5095 has been stuck in committee since March and it is looking as if that’s where it’s going to stay.“It went in front of the [house] pension committee and then the lobbyists came in and killed it,” Joyce said.

If a pension fund like TRS fails, the onus isn’t just on the teachers paying into the fund, but also the taxpayers because the state of Illinois also contributes to TRS. “Taxpayers would be on the hook 100 percent,” Joyce said.

The idea of public pension fund insolvency is worse than taxpayer liability, because there is no precedent if TRS couldn’t pay pensioners, according to Eden Martin, president of the Civic Committee of the Commercial Club of Chicago.

While the Pension Benefit Guaranty Corporation protects private pension plans, public pension funds would face litigation, he said.

If the court decided the state was the guarantor, then the taxpayers would have to pay. However, if the court declares no guarantor then the pension fund runs out of money and beneficiaries don’t get paid. 

“It would be a big mess,” Martin concluded.