The difference between Madoff and the Oregon PERS

Bernie Madoff differs from the managers of the Oregon Public Employees Retirement System investments in one crucial aspect. Madoff pretended to be doing something brilliant to produce steady gains when he was not. The PERS managers are doing it in full view of the public. Amazingly, nobody seems to care.

At the end of October, they were deeply in the hole for the year, but they still were able to brag about doing better than the market. This is straight horse pucky. They are doing better because, for a very large portion (perhaps 20%) of their investments, they know they have lost money but not how much. Their investments in real estate and "private equity" are so illiquid that they don't know what value to assign.

So they are continuing to assign the last value they could come up with. In reality, based on what others in the same asset class have done in the past year, they have likely lost 80% of their value.

There's no great secret to making extra money in an up market. You simply use leverage, borrow at fixed rates, invest at higher returns, and the difference accrues to the small equity base rather than being spread over the whole investment. But as Galbraith wrote in "The Great Crash of 1929," when the market goes down, people discover that the magic of leverage works in both directions. Thus the spectacular gains the PERS enjoyed for several years are quickly turning into massive losses.

The source of all this woe is that the Oregon legislature has declined to fix PERS. It has permitted the managers to make risky investments that, during the good years, went a long way towards backfilling the Unfunded Actuarial Liability (UAL). It was never a sound, long-term strategy and the consequences are coming back to haunt the state.