Pension Funds are taking leverage because they haven't met goals:
Who isn't over-levered at this point?
Recently CalPERS (California Public Employees Retirement System), the countries largest pension fund, has decided to take leverage on their fund. Also, CalPERS is looking at alternative assets like private equity/private debt and real estate (no mention of crypto, but who knows). CalPERS concluded that their current portfolio over 20 years would only return 6.2% when their target was 7%. In reality, that 7% target will not meet the expectations set by employee agreements already in place.
CalPERS is roughly $120 billion short of where it needs to be current for the promised returns. I think most people understand at least some of the reasons why city and state pension funds have underperformed for so long. I have said it for a long time; they over-promised and under-delivered to the city & state employees from the beginning. Part of it was union negotiations that weren't realistic. Part of it was wishful thinking from fund managers who said, "yeah, we can make this happen," knowing full well that they just needed to keep it afloat long enough to retire.
A perfect example of this is the City of Chicago pension fund, which owes ~$32 Billion to its pension funds as of 2020. They need to pay people who are retiring. They take loans from the state, affecting the state budget. They then take loans from the Federal Gov, which affects Jerome Powell's printing machine. It turns into a self-licking ice cream cone of bad ideas because people make unrealistic expectations, and no one wants to tell the truth to fix things.
The new Problem, leverage:
Add in leverage, which is just another word for a loan, and the risk compounds. In CalPERS' situation, it's only 5% of the asset allocation to leverage. The amount dedicated to leverage may grow over time. CALPERS' will likely start a trend where pensions lever up to get the promised returns. Other pension managers will increase the risk over time. In an event where the fed somehow can't keep the ink in the printing machines anymore, it could mean a substantial loss for people who are preparing to retire.
Everyone will say that "oh no, that can't happen. We are structured to handle that risk" see the Chicago pension fund example.
Bonds won't cut it anymore, and too much time has passed with over-reliance on them:
A primary reason these funds constantly underperform is their risk appetite. They are mandated and governed to have minimal risk. This underperformance means a large portion of the fund has invested in fixed income (bonds), usually a safe bet over a long period. However, bond yields have been so low for so long they are essentially useless compared to other asset classes. You could argue that the S&P is a low-risk asset based on the continuous bull market we have seen due to QE in its various forms.
Partially due to government bonds underperformance, inflation, and other asset classes being deemed safe, there will be an increase in risk and the use of leverage to make quick returns in pension funds nationwide. There is no reason to think that this will cause some bubble or macro issue. Because if they were to fail, the federal government would have to bail them out, similar to what we have seen in Chicago, just on a larger scale. It is in everyone's best interest for that not to happen, so pensions will repeatedly kick the can down the road. More junior members of the pension programs will have to put in more money out of their paychecks into the pension.