Money Managers

Detroit's Pension Funds Dogged by Bad Deals


Members of the Detroit Fire Department (DFD) hold signs while protesting in front of the Theodore Levin U.S. Courthouse in Detroit on July 24

Photograph by Jeff Kowalsky/Bloomberg

Members of the Detroit Fire Department (DFD) hold signs while protesting in front of the Theodore Levin U.S. Courthouse in Detroit on July 24

In 2006 businessman Robert Shumake asked the boards of Detroit’s two pension funds—the General Retirement System and the Police and Fire Retirement System—to give him $27 million to invest in real estate. George Orzech, a fire battalion chief who represented uniformed workers as a trustee on their fund’s board, found one thing odd about Shumake’s pitch. “Anybody who knows the first names of trustees in a first meeting has already had meetings with people,” says Orzech, who unsuccessfully opposed the plan. “It was a political deal.”

The deal didn’t work out so well. The general employee pension invested $12 million with Shumake’s fund, Inheritance Capital Group, and the police and fire fund invested $15 million, according to a suit they filed against the company in Wayne County Court in 2011. The stakes were valued at $1.7 million and $11.6 million, respectively, as of June 30, 2011. Inheritance Capital Group filed for bankruptcy in April 2012, and Shumake, who hasn’t been sued and didn’t respond to calls seeking comment, filed for personal bankruptcy in January. Shumake told the boards he was a real estate broker and attended the “Larry Pino Institute of Finance,” the complaint said. But his real estate license had expired, and, according to the suit, the institute doesn’t exist.

Stories of deals gone wrong show how Detroit’s municipal retirement system for 30,000 employees and retirees became a cash cow for a select few. Now these bad investments are coming back to haunt workers and pensioners as the city proposes slashing their benefits in the biggest municipal bankruptcy in U.S. history.

Kevyn Orr, the emergency manager appointed to oversee the city, has said Detroit’s pensions are underfunded by as much as $3.5 billion in part because of unrealistic assumptions of 8 percent annual investment returns. The pensions say the gap between assets and obligations to retirees is $700 million, according to a June 20 statement. Although authorities have investigated investments, the present General Retirement System board is acting responsibly, says its legal counsel, Michael VanOverbeke. He says the fund has fared well compared with other public pensions.

The funds get contributions from the city and employees and invest them in stocks, bonds, private equity, and real estate. Board members, who are chosen by employees, retirees, and Detroit’s mayor, don’t necessarily have investment experience. One trustee is a pastor. Orzech and other members say questionable deals were made from 2006 to 2008, when the boards were influenced by then-Mayor Kwame Kilpatrick, who did prison time for perjury and now faces sentencing for a March 11 conviction on federal corruption and racketeering charges.

The Kilpatrick administration’s sale of $1.4 billion in debt in 2005 to fund the pension created a pool of money that attracted speculative deals, Orzech says. “There was a group of bad actors, and they’ve been busted,” he says. Orzech, first elected to his board in 1988, says it otherwise had a good track record and that new members have tightened control.

The value of real estate held by the General Retirement System plummeted almost 47 percent, or $293.2 million, from June 30, 2008, to June 30, 2012, according to reports filed with the state treasurer. The Police and Fire Retirement System’s real estate investments declined 33 percent, or $228.3 million. That compares with a 3.6 percent gain for that period by the National Council of Real Estate Investment Fiduciaries property index, which gauges a pool of almost 7,200 commercial properties acquired by pensions and nonprofit investors.

The $2 billion general employee fund lost $16 million in fiscal 2010 when it wrote off a housing development near Sarasota, Fla., that fell apart after the real estate bubble burst, according to pension fund records. The $3.2 billion police and fire fund lost about $15 million on 1,100 vacant acres 30 miles east of Dallas that were to be sold to homebuilders. A 2006 loan guarantee for a Westin (HOT) hotel and condos in downtown Detroit cost the two funds $14 million. And that’s just real estate losses. The funds lost more than $20 million investing in a telecommunications company founded by a Detroit businessman, $30 million on a cargo airline, and almost $70 million on collateralized debt obligations—securities backed by a pool of bonds, loans, and other assets.

A real estate adviser to the boards, Chauncey Mayfield, has pleaded guilty to federal bribery charges. He flew Kilpatrick and Jeffrey Beasley, the city’s former treasurer, to Las Vegas for a weekend that included golf, rooms at the Venetian Resort Hotel & Casino, concerts by Toni Braxton and Prince, and massages at the Canyon Ranch Spa, according to a May 2012 U.S. Securities and Exchange Commission complaint. On June 10 of this year, the SEC alleged that Mayfield stole $3.1 million from Detroit’s police and fire pension to buy two strip malls in California. Mayfield and his firm agreed to settle the case, without admitting or denying liability, by paying back the amount.

“In any investment portfolio of any individual or corporation or pension fund, you can find some investments that were not successful,” says VanOverbeke, the attorney representing the General Retirement System. “The individuals sitting as trustees today are conducting appropriate due diligence, meeting with their investment consultant, adopting board governance policies and procedures, and things of that nature.”

Current trustees want to avoid repeating poor decisions, says Mark Diaz, a board member and president of the Detroit Police Officers Association. “We’re there to make damn sure it never happens with us,” he says. “We have a lot of skin in the game. I want to be an old man not concerned about where my meager pension is going to come from.”

The bottom line: Detroit’s two pension funds had losses of 47 percent and 33 percent on real estate investments from 2008 to 2012

Braun is a reporter for Bloomberg News in New York.
Christoff is a reporter for Bloomberg News.

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  • HOT
    (Starwood Hotels & Resorts Worldwide Inc)
    • $83.68 USD
    • -0.66
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