What a difference nine months can make. At the end of last September, the Pension Benefit Guaranty Corporation (PBGC) closed its fiscal year with a deficit of ‘only’ $11bn (€7.9bn) and its director Charles Millard was busy implementing his new “less conservative” investment strategy, under which the majority of the $55bn assets was to be shifted out of bonds and into riskier stocks and alternative asset classes. Now, PBGC’s shortfall has risen to $33.5bn for the first half of fiscal year 2009, the largest in PBGC’s 35-year history, and Millard is also under investigation for alleged conflict of interests in hiring external managers for new investments. Rising bankruptcy levels are also adding stress to PBGC’s balance sheet and the Obama administration could eventually be forced to use taxpayers’ money to bail out this quasi government agency.

One possible remedy is increasing premiums paid by the companies whose pension funds are guaranteed by PBGC. But the prospect of paying more does not appeal to employers and gives them one more reason to abandon traditional defined benefit (DB) pensions, the ones that are insured by PBGC.

Created under the Employee Retirement Income Security Act of 1974, PBCG is a federal corporation that guarantees payment of basic pension benefits for 44m American workers and retirees in more than 29,000 private-sector DB plans. If a company goes bankrupt, the plan is taken over by PBGC, which is financed by corporate premiums and by the assets it inherits when it acquires failed plans. Last year, PBGC paid out $4.29bn in benefits to more than 640,000 people, and collected $1.49bn in insurance premiums.

The General Motors and Chrysler bankruptcies have been threatening to dramatically worsen PBGC’s situation, but thanks to Obama’s help the two Chapter 11 procedures have not affected the pension funds so far. The whole auto industry’s pensions are underfunded by about $7bn; GM’s shortfall is $20bn and Chrysler’s $9bn. But even if the two Detroit auto makers continue to take care of their own pension funds, other companies affected by the industry’s crisis are failing. In the first months of 2009 PBGC took over four pension plans of auto parts makers: Contech US ($8.4m assets, $22m liabilities), Patton Corporation’s GAC and Flxible (sic) pension plans (combined $19.8m assets, $33.8m liabilities), and Intermet ($62m assets, $126m liabilities).

By statute, PBGC can invest corporate premiums only in fixed-income securities, while it is free to invest the inherited assets in other ways. A liability-driven investment policy adopted in 2004 favoured duration-matched bonds and was managed by PIMCO, Prudential Investments, Wellington and Western Asset Management. But Millard - who became the PBGC’s director in December 2007 - decided to look for higher returns and allocate 45% of assets to diversified equities (up from 28% of PBGC’s portfolio in 2007) and 10% to alternative investments such as real estate and private equity. The new strategy was approved in February 2008 by the three members of PBGC’s board, the secretaries of Treasury, Commerce, and Labor departments, but was widely criticised because of its risks.

Also, it was never fully implemented, according to Vince Snowbarger, who became PBGC’s acting director after Millard resigned in January. As of 30 April, PBGC’s investment portfolio consisted of 30% equities, 68% bonds, and less than 2% alternatives, which were inherited from failed pension plans. So the financial crisis may not have affected PBGC too badly: its portfolio lost 6.5% in the fiscal year ended in September 2008, compared with a gain of 7.2% in 2007, according to PGBC’s annual report; equity assets lost 23%, while fixed-income investments returned 1.6%.

Only last October, Millard was able to award three Wall Street firms - Goldman Sachs, JPMorgan and BlackRock - with contracts to manage $2.5bn in real estate and private equity. The three companies were the winners among 16 bidders, and would have earned more than $100m in fees. But according to the PBGC’s inspector, Millard acted improperly, helping the three firms win the contracts in exchange for personal favours.The former director - who before the PBGC’s appointment used to be a Lehman Brothers’ managing director and had worked for New York Mayor Rudolph Giuliani’s administration - denies any wrongdoing, but is being investigated by Congress.

The contracts have been cancelled and the new Labor Secretary Hilda Solis, chairwoman of the PBGC’s board, has urged a suspension of the entire controversial strategy.