Asymmetrical Information

I am a small fry working for a pensions consulting company, and I have a few things to point out about the way that pensions are handled in this country.

Pension funds, much like life insurance funds, are heavily regulated in order to make sure that both are solvent over the projected lifetime of the fund. While the regulations and laws that govern life insurance are generally sound, in that life insurance companies are required to have positive reserves, it is not so for pensions.

I am just starting to learn the particulars of the regulatory insanity for pensions, but what I do know is that keeping a pension fund in the good graces of the regulators, and being well funded is a precarious state. If a plan is very well funded due to a momentary spell of good market returns on its assets (a temporary thing), it may even be required to increase benefits (a permanent thing) in order to avoid penalties imposed by the IRS and the Department of Labor.

Government programmes, on the other hand, have a tendency not to self correct until the crisis is upon us

Not a troll, just curious: could you give an example of a "programme" (and please, Jane, come back to God's country, you're starting to go native on us...) that has not self corrected and thus had to be fixed after a crisis? I'm talking domestic programs, not external threats like terrorism or the like.

Off the top of my head, jimbo, the S and L crisis, which, at it's heart, was caused by Government-backed deposit insurance, qualifies. I fear that Fannie and Freddie may be building to a similar crescendo.

jimbo,

Ag subsidies.

Well, I don't remember all the details of the S&L crisis, but wasn't that a case where it was the "reforms" (letting S&Ls get into lines of business they knew nothing about) cause the crisis?

And as for ag subsidies, I'm not a great fan, but when did they become a "crisis"?

Government is "actuarially sound" only because it has the ability to tax. Individuals can be actuarially sound if they take into account the risks they face as they make their investment and consumption decisions. But they'll not take those risks into account if they perceive that they'll be bailed out by government, that is, by other people.

The S&L's were in the same line of business they had always been in, in fact, the laws pertaining to the creation and implementation of the S&L's were quite strict about the line of business they were in: mortages. TEFRA '86 made soem tax changes that hit real estate really really hard, both commercial and residential, and the S&L's started buying riskier mortage investments such as CMO residuals.

But the kicker was that the S&L's had to price their collateral to market, and not to the end of the collateral life. So, a 30 year mortage on a house which was always paid on time was valued at the current market price and instantly was considered a non-performing loan instead of a performing loan, even though there was no hint that the mortgage payments wouldn't continue to be made. So even for good loans, the collateral value went down and the under-collaterization of the mortages did the S&L's in. And FIRREA made it even worse, a perfect example of Congress throwing gasoline on a fire to put it out.

It had nothing to do with "riskier" investments--teh riskier investments were the equivalent of the S&L's trying to find a life raft after TEFRA '86 sank their boat. Another example of the Law of Unintended Consequences.

Well, I don't remember all the details of the S&L crisis, but wasn't that a case where it was the "reforms" (letting S&Ls get into lines of business they knew nothing about) cause the crisis?

The biggest deal with the S&L crisis was that the old tax law had some fairly high tax loopholes that were inefficient for the economy but made it worth it to own money-losing property for the tax benefits.

The 1986 tax reform bill got rid of many loopholes. (Yay!-- although they come back.) This, in the long run, was good for the economy. But, you had a lot of S&Ls, real estate guys like Donald Trump, and all sorts of other people who had made plenty of investments counting on the old tax code to make them worth it. Change the tax code and suddenly these people were stuck with a lot of money-losing real estate investments that didn't have the tax benefits that were why they had bought them in the first place. So values on these properties that lost their loopholes plummeted. Result-- lots of real estate loans went bad because conditions changed. The S&Ls loaned on the basis of the properties being worth more thanks to their loophole status. Thus, way more bankruptcies and bad loans than expected, and the S&Ls lost a lot of money, money that they hadn't expected to lose.

The end result was the crisis. The overall benefits to the economy of the tax reform could be enough to outweigh the bailout, though.

Feel free to analogize to the situation of changing bankruptcy laws, and how that affects people who got loans under the old system.

Jane,

Re; "a system of minimal government insurance for those who have been unlucky, in life or investments, combined with a regulated forced savings plan to make sure that those who aren't unlucky aren't tempted to free-ride on society, and incentives to employers to encourage additional savings among employees."

I agree. But I don't believe that free-riders are so serious a problem as to require a large mandatory savings program. Simply don't offer benefits large enough to encourage free-riders. If you're handicapped, you get a decent standard of living. If you're just lazy, or someone who refuses to save, you get to eat, but you have to live in a group home. What is needed are incentives for savings (carrot and stick), and a minimal safety net funded with progressive taxation.

My dad worked for Polaroid for most of his living, working years. If you want to see a company that screwed its employees out of health care, retirement, and death benefits thats a company worth examining.

While employees got a check for 44 dollars each, the asshats who moved in as execs when the company was in backruptcy - pretty much just to divide the company up - received millions each.

David Arceneaux,

Is that an ERISA guideline, or something more specific? Do you know what Regulatory code causes this to happen?

There was some talk during the last election cycle about portable pensions.
The current scheme of companies running these with their hand in and out of the till has always seemed problematic. Take ITV Industries, a now defunct steel company, which was allowed to "borrow" from the company pendion plan by the bankrupcy court till finally eveybody had nothing. United at least dumped the pensioners into a government program, the ITV pensioner got nothing.
Companies are now shifting to "pay-as-you-go" pension and accounting structures that would greatly facilitate the portable pension idea. Companies make comtributions directly to an private/personal portable pension account of each employee, much like a 401K account. This idea accomodates the majority of employees that don't last 5, 10 or more years required toward vesting. It's been long overdue and perhaps United will force the issue.

people may make bad judgements...[but]... there's no evidence that the government--which is, after all, elected by those same people--makes better ones

Oh, how I wish more people understood that. Plus, as pointed out, governements are really, really bad at self-correcting when they make bad judgements.

The S and L crisis had nany ingrediants, but absent a huge guarantee from the federal government to make depositers whole, there is no crisis, given that large, completely risk-averse, depositors had other means with which to achieve their goals. Instead, the government created a gigantic moral hazard, and gee whiz whilikers golly gee, the moral hazard created a crisis! Who'da' thunk it?

Another risk for government-controlled pension assets is corruption. My case in point is CalPers. Controlled by Democratic politicans, they ventured into "shareholder activism" - another name for extortion of the private sector. I think that the trustees of CalPers have not been acting with full fiduciary responsiblities to their current and future pensioners. Just how did South African or Israeli divestigure efforts benefit 80 year old pensioners?

As to governments being "actuarily sound", their prime advantage is the scope of coverage - they can cover the whole population rather than selected or residual subgroups.

"This won't make anyone ideologically happy."

Perhaps there is therefore a problem with the current ideological choices?

Perhaps I'm just becoming a fuzzy-headed liberal in my old age, but I like what CalPERS is doing. Not divestiture from Israel (which, as a point of fact, they haven't done), but beating up on complacent, incestuous, or otherwise poorly performing boards of directors.

The board theoretically answers to the shareholders, but in practice it's nearly impossible to put together enough shares to vote meaningful change. Look at the ridiculous tripe peddled by "executive compensation consultants" and MCI trying to take a 30% lower buyout offer. In order for the system to work, large institutional investors need to make trouble when they see things going wrong, and it seems like pension fund managers are at a sweet spot of fund size and "outsider" status.

As for social security, feh. Combine IRAs, 401(k)s, 403(b)s, Keogh plans (whatever the hell they are) into one portable tax-advantaged retirement plan, and if it comes to pass that social security benefits cost more than social security taxes, raise the one or cut the other. And deal with the general fund deficit, which is predicted to be higher in 2005 alone than the social security deficit will be through 2020.

Jimbo,

Two big ones in housing.

The FHA mortgage fiascos of a few decades ago. And of course the housing projects crises of the late 60s, 70s, 80s and early 90s that we're still not fully recovered from.

I think the devastation both caused the inner cities qualify as crises to be sure.

SS 1983 would be a good example of a govt program that only changed to avert a crisis at the last minute.

It seems to me that when the PBGC (i.e us) bails out some company's pension fund that it ought to move to the front of the line of creditors. In the United Airline case they should have gotten title to the aircraft, landing rights, etc., and any other residual value left in the corporation.

Kevin: That goose won't fly. Using the airlines as an example. First, by reducing the availability of assets to collaterialize debts, you would make it impossible for companies to obtain financing before or after bankruptcy. Banks would not lend to them unless they got rid of their pension plans. Every company recieves credit from its vendors for inputs, airlines buy feul, and lots of it, retailers buy merchandise to stock their stores, and so on. Vendors would only do business on a C.O.D. basis.

If your proposal were in place. United would be liquidated and in addition to loosing their pensions, its workers would lose their jobs.

Who's right? Well, basically, there are three entities that can bear retirement risk: a company, a person, or a government.

There are problems with all three. People are too small to be actuarially sound; they can be wiped out by adverse events. Also, some of them are incredibly stupid about money; others like to gamble.

Jane has stumbled upon the actual reasoning behind Social Security here. You have three assets with different strengths and weaknesses. Individuals are best able to shift gears to recognize opportunities and risks but are often small and able to be blown away by even a minor 'adverse event'. Companies are less able to shift gears but typically are larger and better able to insure themselves against adverse events. Gov't has near infinite power to shield itself since it literally has access to almost the entire economy through its power to tax and regulate. On the other hand gov't programs are difficult to contain and hard to reform or change.

The answer FDR's generation came up with was diversification. The base would be Social Security, a form of 'forced savings' that would provide a guarantee against poverty (or at least dire poverty) and some form of benefit for just about everyone who lived to be too old to work. The other base would be corporate pensions. Finally supplemented by private savings (most people forget here that the largest form of personal savings comes in the form of real estate...owning their own house). Any good portfolio manager will tell you that risk can be lowered by diversity.

Today corporate pensions are giving way to 401K's/IRA's. That may or may not be a bad thing but it is interesting in that it shifts retirement away from 2/3rds annuity (you get a check every month for the rest of your life) and 1/3rd 'nestegg' (you can sell your house or cash in your stocks for a one time lump sum that you have to make last for your life but you can leave to your children if you wish) to 2/3rds nest egg (401K savings and savings in non-retirement accounts like home equity). Why would it be sensible to push the balance even more against the annuity concept?

Jake,

Thanks for pointing out my exaggeration. All shareholder activism by public pension funds (including CalPers) is not corruption. I too have respect and gratitude for some of the initiatives taken against corporate management so far.

Yet you must agree that the POTENTIAL remains for abuse. I believe I've seen more of that than I have shareholder activism that was truly of benefit for the commonweal.

Both sides are correct but the more power is concentrated in the control of public pension funds the greater the potential, the temptation, and the consequences of political misfeasance.

You suggest that liberals adored the corporate defined benefits plans. This liberal never has. I prefer to have the private portion of our retirement plans in the form of defined contribution plans SO LONG As we have a public defined benefits plan such as the Soc. Sec. system. In the private sector, some risks are only shifted from one group to another. Diversifiable risks can be partially mitigated within the private sector, but the private sector has yet to allow for full diversification across people and across time. What United Airlines has done has to be to unload the risks that would be borne by equity holders (where diversification is easiest) onto the workers. And you defend this abuse of the bankruptcy laws?

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