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3/9/2010
Defined benefit plan for WI public employees must go
‘In effect, [public pension fund managers are] going to Las Vegas,” says Frederick E. Rowe, a Dallas investor and former chairman of the Texas Pension Review Board. “Double up to catch up.”
That’s according to today’s NY Times’ review of public pension funds – “quietly and gradually” moving out of stocks, into more long-term bonds – and needing to catch up for dismal returns the last couple of years.
But… aiming for higher returns comes with more risk, including investments in
commodity futures, junk bonds, foreign stocks, deeply discounted mortgage-backed securities and margin investing. And some states that previously shunned hedge funds are trying them now.
The problem is that when public pension funds reduce their return assumptions, their liabilities skyrocket – and current contributions then must skyrocket as well to counter the shortfall. Needless to say, that’s anathema to taxpayers – and most certainly to public employee unions.
In addition to Texas, the Colorado state pension fund, Wyoming, California (Calpers) and North Carolina are mentioned in today’s piece.
“[North Carolina’s new law allowing 5% of the state pension fund’s assets in more risky ‘credit opportunities’] doesn’t pass the smell test,” said Edward Macheski, a retired money manager living in North Carolina. “North Carolina’s assumption is 7.25 percent, and they haven’t matched it in 10 years.” He went to a recent meeting of the state treasurer’s advisory board, armed with a list of questions about the investment policy. But the board voted not to permit any public discussion.
And then there’s Wisconsin. Pioneering new ground.
Wisconsin, meanwhile, has become one of the first states to adopt an investment strategy called “risk parity,” which involves borrowing extra money for the pension portfolio and investing it in a type of Treasury bond that will pay higher interest if inflation rises.
…. Wisconsin decided it could lower its equities but preserve its assumption if it also added a significant amount of leverage to its pension fund, by using a variety of derivative instruments, like swaps, futures or repurchase agreements.
A FoxPolitics News piece the end of January featured a couple of critical pieces that drew attention to Wisconsin’s foray into what some say is dangerous leveraging of their assets. FP reader Brian Heyer pointed out a must-read by respected investments blogger Mike Shedlock (Mish) which references a January 27 Wall Street Journal piece about the Investment Board’s (SWIB) effort to “juice returns” and does an excellent job breaking down and questioning SWIB’s decision. Mish analyzes and critiques Wisconsin’s decision further with a January 29 piece that delves into a murky world of hedge funds and free lunches.
…. What happens to all those geniuses who believe in the "free lunch theory" when the trades start to go the other way?
I will tell you what happens - Goldman Sachs and hedged funds not involved will bet against it, in size. The system inherently takes advantage of leverage and weakness. That is what sunk Bear Stearns.
Mish brought together pension problems from around the country in this January 13 piece.
Unions are half the problem. The other half of the problem is bureaucrats caving in to Union demands. It is insane for 57% of money being spent on police and fire services to be for pensions. I am hoping such contracts get voided. One way to do it is by municipal bankruptcies.
….Defined benefit plans must go. Taxpayers simply cannot afford the burden.
Indeed. It’s time that local, state and federal governments must, as corporate America has, move to defined contribution plans.
Jo Egelhoff, FoxPolitics.net
COMMENTS
Another piece of the puzzle (so that I have read) is that many of these instruments are not traded on open markets and not subject to public review. Those markets should be regulated as has been proposed by some bills that have yet to pass. We got into the current economic mess in a large part because the risky mortgages and the like disappeared into these complex and almost unfathomable instruments. If these funds fail we the taxpayer will be on the hook just like we are ultimately on the hook for the bailout of AIG.
dave allen (Tue Mar 09 06:44:13 2010)
Mish wrote, "Taxpayers simply cannot afford the burden." True enough. Also true is that taxpayers simply SHOULD not carry the burden, even if they could.
Ron Zahn (Tue Mar 09 08:23:58 2010)
Jo - thank you for again bringing more attention to this important issue. We need leadership across Wisconsin to reflect what the (increasingly dis-employed) public realizes: 1) government agents are overpaid for whatever benefits to society they believe they provide, and 2) gratuitous defined benefit pension plans for government agents openly loot younger workers.
If there is disagreement with my contentions above, then immediately open all government employment positions to new applicants at $8 per hour less pay AND with zero defined benefit plan accruals going forward. [Pay out existing benefits, of course.] Watch the line of applicants stretch around the block. Government payrolls do not reflect reality.
[As an aside: the majority of American union members are no longer industrious blue collar workers. Whenever you hear, "union proud" imagine a building full of government employees, pushing paper, permits, and red tape from one side of the desk to the other, entangling you in the process. ]
Dave - you touch on a good point. Transparency is critical. I'll add that it is also vital to enforce economic consequences for bad decisions. If an investment bank makes mistakes, they get liquidated, and the owners and bond holders get wiped out. Period. With bailouts, the money and risk is transferred from the taxpayer in order to keep owners and manager in place, and maintain the power structures. The bailouts are about the continuation of political power (and that goes back in American history to the canals, then railroads, and all the way up to the modern banksters.)
Brian Heyer, CPA (Tue Mar 09 09:27:20 2010)
Jo: Good job of summarizing this critical cost issue. Remembe when pensions, medical insurance, etc, were called, "FRINGE benfits"? 50 % of Payroll is absurd!
One other aspect of this problem I'd like to high light is that all our Wisconsin elected Representatives are covered under the same Plan and thus have a vested interest in perpetuating this outrageous system. NO ONE is representing the Tax Payer. And, it applies to BOTH Parties. As I recall, under Tommy's Administration the Retirement Formula was increased three (3) times. I'm sure,based on the "Final Average Earnings" concept in the Plan that Tommy probably has the highest monthly benefit of any Elected Represntative. The Tax Payer always loses. GLS
Glenn L Schilling (Tue Mar 09 10:10:16 2010)
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