Pension Tension

In These Times (ITT) devotes most of its issue to pension politics. I did some work on public employee pensions a while back at the Government Accountability Office, then got into some fights about it online with friends, coincidentally in the same magazine. After a lengthy preamble, I offer a few notes on the ITT analyses.

The nub of the controversy started with the deluge of articles foretelling doom for public employee pensions. At GAO, we were mandated to assess the credibility of these forecasts. Our finding was that while there were a few basket cases (hello, Illinois!), most state government funds were in decent shape.

Fun fact: a fund analyst told me there was zero chance the heavily indebted, variously-fucked-up state of Illinois would default on its debts, since by state law, bondholders had first dibs on state government revenues. Other public services no matter how vital were ranked below the bond interest obligations.

The fundamental financial fact is that state and local governments, not to mention private corporations, cannot print money. They cannot apply revenues to a fund, then go and spend the money regardless, as the Feds can do currently with the Social Security Trust Funds. State and local governments have to set aside savings composed of real assets. The savings go for assorted purposes — investment in infrastructure, employee pensions, and temporary emergencies (‘rainy day funds’). All such funds are targeted by the Right, in different ways.

It is interesting to note that in some European social-democracies, governments deliberately build up funds composed of real assets. A well-taxed economy can finance more public saving and investment. Moreover, these funds take ownership of shares in private firms — nationalizing the means of production. The nation of Norway is a leading example.

In the depraved political culture of the U.S., the public emergency funds are usually attacked as ‘slush funds’ that have resulted from “over-taxation.” The buried objective is to exploit emergencies, such as from an economic downturn, to ratchet down total public spending by forcing permanent spending cuts. The target is the prudent fiscal practice of smoothing over revenue blips to prevent disruption of public services. Naturally, the Right doesn’t care for the smooth functioning of programs. They want to be able to complain about dysfunctional public services.

In the context of every crisis creating opportunity, it also follows that crises provide chances to ratchet up public spending, making possible permanent expansions of social welfare programs. Any Democratic public official who neglects such openings should find another profession.

The public employee pension funds are exploited by craven, short-sighted public officials to finance one-time gifts to the public, typically tax cuts. The result is that such funds can develop actuarial imbalances — a mismatch between projected liabilities and assets. Christine Whitman was a practitioner of this scam as governor of New Jersey. Chris Christie took a bite out of teachers’ savings during his term as NJ governor. Elected officials’ time horizons are always shorter than the necessary lives of pension funds.

The infrastructure funds raise fewer hackles. I’m guessing their projects appeal more to business and their financing provides opportunities to the rich, in the form of bond sales, though conservatives tend to automatically oppose bond issues that require consent of the electorate. When asked to vote, I automatically support all new bond issues. I don’t even bother to read the descriptions. Just do it.

In general, employee pensions provide workers with exposure to the gains provided by the stock market. This in and of itself is not a bad thing, though there are better ways to do it. Growth in GDP can finance expansion of Social Security. Higher taxes can support public saving, as mentioned above. The problem is when individuals acquire control over their own money, through the proliferation of 401ks and IRAs. People suck at investing. I suck at investing, and I’ve been reading books about investing and finance for thirty years.

It has long been established that well-trained fund managers who work the livelong day with the sole objective of making money usually fail to match the performance of a simple S&P index, which anyone can buy into. What else is the individual, amateur investor to do? That’s why the progressive position has always leaned towards regulated pension schemes that preclude excessive risk. And there is always Social Security, More Not Less. The objective is to ensure a retirement that escapes destitution or dependence on others, since left to their own devices there are always people who paint themselves into a financial corner.

The main model for pensions used to be what are known as “defined benefit,” as opposed to “defined contribution” (‘DB’ versus ‘DC’ plans) which means the fund pays out predictable benefits while its assets are managed by trustees. With DC plans, the workers have individual accounts whose pay-outs depend on how much they choose to deposit through the years and how they allocated their investments. DB plans provide more security than funds in which the beneficiaries can make poor decisions about their own contributions, asset allocation, and withdrawals. Another factor is that DB plans were instituted when labor had more power, so their terms are more generous. Conversion from DB to DC usually entails benefit cuts for the workers. In fact, that is their motivation.

The scare about the public employee DB pensions was all about the insufficiency of their assets, relative to projected liabilities. The left went in for some of this too. I could note that for all the squawking, there has been no big, adverse event in pension fund solvency.

The simplest remedy for projected fund shortfalls is to just increase contributions to the fund. The fixes promoted by the Right invariably entail benefit cuts, usually through complicated conversion of DB plans into DC ones. The line from the Right is that workers should pay for their own plans, which they did already, partly in the form of government or employer contributions agreed upon by contract.

I’ve already mentioned expansions of Social Security, a public DB social insurance plan and another target of the Right in the form of bogus predictions of funding doom. The fact is that existing DB plans, 401ks, and IRA’s provide tax preferences (‘loopholes’ if you don’t like them) to savers, actually a subsidy to capital ownership, albeit to millions of unrich workers and retirees.

Proposals for expansion of such programs, advanced in different forms by both Donald Trump and Bernie Sanders, in effect move the existing individual income tax further towards being a consumption tax. The more you exempt returns to savings from taxation, the more you narrow the tax base to consumption. That’s the downside.

So what about my friends at In These Times? The leading question raised therein is the possibility of using fund balances, which are considerable, in the trillions of dollars, to influence corporate decisions. The authors do not pause to consider how this would sit with prospective fund beneficiaries — the blessed workers. I applaud their enthusiasm, and I would certainly welcome more militance and solidarity in such avenues, but my financial future would not be at risk. “Pension fund socialism” has been a lefty fever-dream for some time, but it hasn’t happened yet.

We could at least hope that the worker funds eliminate ties with anti-union firms and principals. ITT highlights the egregious case of funds going to a company run by an Elon Musk confederate who was put in the leadership of the comically-named Department of Government Efficiency. In a similar vein, there have been cases where union funds invest in companies that relocate their production off-shore, clearly out of the reach of any union representation.

At the Economic Policy Institute, we had our own little employee union local. You might think that at a lefty shop, the workers would be gung ho to fight fight fight. (And the management, Ha!) You would be wrong. We had a few firebrand professional economists but mostly administrative assistants, don’t call them “secretaries,” and other support personnel whose principal concern was meeting their family obligations.

Maybe I’m too pessimistic, but my view is informed by experience. In a nutshell, it would not pay to overestimate workers’ willingness to sacrifice a bit of return on their savings for the sake of broader social issues, such as avoiding the purchase of bonds sold by fossil fuel companies. I note that social-democratic model Norway is piling up huge savings from the income of its North Sea oil extraction.

So what should the funds should invest in? The ITT writers counsel conservative holdings of big index funds, which represent a diversified mix of ordinary stocks and bonds. Here they are on solid ground. Diddling with individual companies or trying to time the market is a mug’s game. That is the problem with buying into companies. Individual firms are just too risky for the average person, no matter how craven their policies. The luxury of pension funds is they can “buy and hold,” since in the long run stocks go up. If they don’t, our problems will go beyond pension fund solvency.

Even worse, some funds get interested in very risky projects, just as individuals do. It’s called “reaching for yield” in the financial columns. Everybody knows you shouldn’t do it, and we do it anyway. On a collective level, union-led investment policies can finance the destruction of trade unionism — current generations of workers screwing over the next. It’s a jungle out there.

ITT chronicles fund investments that go bad. They don’t go into those that perform above average. There have been some. The trouble is knowing what will pay off in advance. Most people do not. More risk enables higher returns, but that’s a two-way street.

ITT wants to see funds focus on so-called “ESG” (economic, social, and governance) investment. I would not dissent from this recommendation, but it should be realized that this departs from the lowest-risk option, investing in everything for maximum diversification, or going the public DB route. I take the point that certain investments sacrifice the social good or the well-being of trade unionism for moderately higher returns, so they present a different kind of risk. Here I would say it pays to be selective in one’s activism, to pick the battles or the hills you are willing to die on.

It doesn’t pay to get too far ahead of the workers, what we could call vanguardism of a different type.