Ten Years after the Global Financial Crisis: A Pension Fund's Retrospective

Ebony Jones manages asset allocation for Colorado's Public Employee Retirement Association (PERA). She is worried that some asset price measures are approaching levels observed prior to the Great Recession, and she is pondering whether she should shift PERA's asset allocation toward cash and fixed-income investments as a precaution. To put the current market situation in perspective, she looks back at the causes and consequences of the Great Recession. Were there clear warning signs of asset bubbles and impending recession prior to 2008? To what extent does today's economy resemble the pre-2008 economy, and what are the implications for Colorado's retirees and the broader economy if stocks and real estate are due for a correction?The case was written for use in Darden's Global Economies and Markets (GEM) core course during a class on the causes of the Great Recession. Each class in the course focuses on a different subset of exogenous variables in the IS/LM AD/AS model that underpins the course. This class focuses on shocks to wealth, consumer confidence, and credit supply, each of which was increasing during the run-up to the crisis and subsequently plummeted. Excerpt UVA-GEM-0163 Rev. Jul. 22, 2019 Ten Years after the Global Financial Crisis: A Pension Fund's Retrospective Ebony Jones felt the burden of responsibility on her shoulders. She and her team managed the assets of Colorado's pension fund, the Colorado Public Employee Retirement Association (PERA). The fund's returns determined the extent to which PERA could meet its obligations to beneficiaries. If the value of PERA's assets dropped or failed to increase at the expected rate, then retirement benefits (for current and/or future retirees) would be cut or Coloradans' taxes would be increased to pay for expected benefit levels (or both). Either way, the well-being of many Coloradans directly depended on PERA. Any funding shortfalls would likely have indirect implications for Colorado's economy, as taxpayers and retirees would cut back on spending at local Colorado businesses. These concerns were ever-present for Jones, but they felt more salient recently. Her specific worry was that valuations for many of PERA's assets appeared high, and she wondered whether asset prices would continue their recent upward trend or fall toward historical averages. Two asset classes that featured prominently in PERA's portfolio—stocks and real estate—appeared potentially prone to a downturn, and Jones wondered whether PERA should reallocate the portfolio toward cash or fixed-income asset classes. By some metrics, stock prices were at levels observed only prior to large crashes. The cyclically adjusted price-to-earnings ratio, for example, was higher than it was just prior to the stock market crash of 1929 and much higher than a recent peak prior to 2008 (see Exhibit 1). Home prices were also approaching levels seen only prior to the 2008 housing market crash (see Exhibit 2). Jones knew that predicting asset prices was nearly impossible. But she was also aware of how devastating the global financial crisis—just a decade prior—was to PERA and to Colorado's economy. And she was sympathetic to the views summarized by Financial Times's John Authers: . . .