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More on that Broken Stool

The three legged stool known as retirement savings is broken: pension, personal savings and social security.  I came across more disturbing news regarding pensions and a proposal to address the problem. 

The financial crisis has exposed major weaknesses or flaws in our economy.  Pension funds, both private and public, were no exception.  Pension funds have essentially become hedge funds that invest in riskier investments in the quest for higher and higher returns.  One would think that pension funds would be more conservative with investing - nah, that’s old school.  The problem may get worse because now pension funds, particularly the hired money managers of the funds, may be under pressure to compensate for losses resulting from the financial crisis and in doing so may undertake even more riskier investment strategies out of desperation. 

How bad is it?

Private pensions have gone from 109% funded in 2007 to 79% funded in 2008 - an estimated shortfall of $400 billion.  The shortfall for public pensions provided by state and municipalities is estimated as high as $2 trillion.  Then there is the problem with the Pension Benefit Guaranty Corporation (PBGC) - the government agency that insures private pension plans.  In 2009, PBGC had an overall deficit of $22 billion and is underfunded in the long term.

Today, pension funds are managed by groups of manager managers which could invest pension funds in real estate, hedge funds, private equity funds, commodities and other very risky investments.  The financial crisis may have caused pension fund money managers to become more desperate and take on even more risk.  Check out these two examples:

One Inflation Threat You Haven’t Of

Pensions are supposed to be among the most conservatively managed portfolios, since millions of retirees rely on income produced from them. But because managers at public pensions are frustrated with the returns of hedge funds and private-equity investments, they’re turning to a classic, but nonetheless risky, tactic to juice returns. The pensions are borrowing against their high-quality bonds, especially government or corporate debt, and reducing their exposure to stock.

and US pension fund eyes commodity investments

The US’s second-biggest public pension fund is poised to make its first investment in commodities as a hedge against the risk of rising inflation, in the latest sign of growing investor appetite for raw materials.

Of course, pension fund PR people say that a small percentage of funds will be invested in these risky investments.  Yeah right, then the quest for higher and higher returns really takes off and before anyone knows it that small percentage turns into 20-25% of funds.  Stop the madness now.  After all we are talking about retirement benefits - money people are counting on to retire. 

Proposal

Yeva Nersisyan and L. Randall Wray offer the following alternative:

Workers would be far better off if their employers were obligated to fully fund pensions with investments restricted to Treasury debt. At most, each pension plan would require a very small management staff that could simply log on to http://www.treasurydirect.gov to transfer funds out of the employing firm’s bank deposit and into Treasuries. Unlike pricing packaged subprime loans and derivatives, this is not rocket science.  Good-bye, fund managers and Wall Street sales staff.

Indeed, this raises the question, Should the federal government promote and protect pensions at all? Since there is no strong reason to believe that managed funds will provide a net return that is above the return on U.S. Treasuries, it would be far better to remove the tax advantages and government guarantees provided to pension plans, and instead allow individuals to put their savings directly into Treasuries, which are automatically government-backed and provide a risk-free return. 

The U.S. retirement system is supposed to rest on a three legged stool: pensions, individual savings, and Social Security.  Pensions are mostly employer related, and are seriously underfunded and directed toward defined-contribution plans. There are also huge and growing administrative problems posed by the transformation of the American workplace (e.g., the typical worker frequently switches jobs, and the lifespan of firms is measured in years rather than decades). The problem with private saving is that Americans do not save enough for their retirement, and they could be duped out of their savings by unscrupulous financial institutions selling risky investments.  Thus, the best solution would be to eliminate government support for pension plans and private saving, and instead boost Social Security to ensure that anyone who works long enough to qualify will achieve a comfortable retirement. 

The U.S. financial system is still far too big even after the crisis. In our view, it makes no economic sense to send as much as 40 percent of corporate profits to the finance, insurance, and real estate (FIRE) sector, as we did at the peak of the bubble — and we seem to be restoring the sector’s share even now, as the financial sector has rallied. Moreover, there is a concerted effort to convince Americans that Social Security is broke; but Social Security is a federal government program, and as such it cannot become insolvent (see, in particular, Papadimitriou and Wray 1999). All we need is a strengthened Social Security program with a government guarantee behind the promised benefits.

Source: The Trouble with Pensions: Toward an Alternative Public Policy to Support Retirement

Good luck.