For years, federal and state workers, along with employees of large corporations, relied on the security of their pension funds for retirement. But facing demands for higher returns, fund managers have opted for riskier and riskier investments. For the California Public Employees' Retirement System, or CalPERS, one such investment has turned sour.

The Wall Street Journal reports LandSource Community Development LLC, a partnership in which CalPERS owns a majority stake, filed for bankruptcy late Sunday. Although it secured a $135 million credit line from Barclays Bank PLC (BCS) to pay for bankruptcy-related expenses, LandSource's future is still uncertain.

In February 2007, CalPERS dumped almost $1 billion into the venture, which owns a vast amount of undeveloped land just north of Los Angeles. The transaction netted $660 million apiece for homebuilder Lennar (LEN) and hedge fund Cerberus Capital, which had previously shared ownership of the investment.

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CalPERS' timing couldn't have been worse.

Raw land was in high demand during the housing boom. Homebuilders churned out McMansions miles away from city centers as buyers were willing to travel long distances to and from work for bigger, safer, cheaper houses. Now, with the real estate bubbled popped, fuel prices at record highs and the economy slowing down, that same land is being dumped at pennies on the dollar.

Homebuilders, strapped for cash and incurring huge losses on falling land values, are trying desperately to unload unused tracts. Financial Week reports that last month Centex (CTX) sold three properties with a book value of $528 million to a group of hedge funds for $161 million. According to Moody's, big homebuilders like D.R. Horton (DHI), Pulte Homes (PHM) and Toll Brothers (TOL) have written off almost $20 billion in land impairments.

All this adds up to a mess for CalPERS - the fund could lose its entire investment. The developer claims LandSource will emerge from bankruptcy and turn a profit when the real estate market stabilizes. It neglected to mention, however, when that impending stabilization would occur.