This is how the game is played: promise the rubes anything but reserve the right to break the promise. If you get caught, cover it up, admit nothing, and keep on with it. When the Securities and Exchange Commission discovered that the state of Illinois had been playing that game with its plan promises, it gave them a “tsk tsk bad boy bad boy!” slap on the wrist. No fines, no penalties, nothing. Just a “don’t do that again because we’re watching you” warning. It’s just the sort of fraudulent financial oversight that begs for exposure.

Here is how the scam worked. Back in 1994 the state of Illinois knew that it had made pension promises that it knew it couldn’t keep, so it set up a system whereby they would make the required pension contributions to bring the plans into compliance with ordinary accounting standards. But not right away. They put off actually making those contributions into sometime into the future. When the plans ran short of funds in the mid 2000s, it issued bonds to cover the shortfall by telling investors that everything was just peachy. So the investors overpaid for junk bonds but didn’t know it. That was almost 10 years ago and the is just now getting around to it.

Here’s how the New York Times explained part of the :

In announcing a settlement with the state on Monday, the Securities and Exchange Commission accused Illinois of claiming that it had been properly funding public workers’ plans when it had not. In particular, it cited the period from 2005 to 2009, when Illinois also issued $2.2 billion in bonds.

But the investors who bought them thought they were buying highly rated bonds. They weren’t:

The growing hole in the state pension system put increasing pressure on Illinois’ own finances during that time, raising the risk that at some point the state would not be able to pay for everything … The risk grew greater every year, the S.E.C. said, but investors could not see it by looking at Illinois’ disclosures.

In effect, that meant investors overpaid for bonds of a lower value than they were made out to have…

That’s a clumsy way of saying that Illinois deceived – defrauded – its investors.

And the fraud is actually worse even than the SEC uncovered. One of the basic underlying assumptions that determines how much a state must contribute to a pension plan is how much those contributions will earn before they are paid out. Care to guess what that rate of return assumption is in Illinois? Well, a 30-year US Treasury Bond is now paying about 3.5%. One might reasonably expect then that, given the long-term nature of most pension plans – payouts being made in the distant future – that perhaps a return assumption in the 4-5% area might be reasonable. In Illinois, the land of wonder and wind and generosity when other peoples’ money, the return assumption is an amazing, astounding, astronomical 8.2%! And what does that do to the amount of contributions needed to be made to make the math work out? Much much less than is really needed. So there’s even a fraud within the fraud.

And by the way, in case you were thinking that the SEC is in there to protect the taxpayers and the pension beneficiaries, think again. They are there to protect the investors. The pensioners and the taxpayers can go hang. Here’s how the Times tells it:

The S.E.C. has cited the harm done to the investors who bought the governments’ bonds — not the retirees whose pensions were at risk, or the taxpayers who found themselves expected to make outlays they never agreed to. The S.E.C.’s mission is to uphold the integrity of the capital markets, not to protect retirees or promote balanced budgets.

And so, in disclosing the fraud, no one is made whole. There are no charges, no penalties, no jail time, nothing. Just a “don’t do that again, boys, and have a nice day.” Kind of restores your faith in the regulatory system, doesn’t it?

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