This op-ed originally appeared in Forbes on November 4th, 2019.
Ahead of the Great Recession of 2008-2009, housing prices were increasing by about 5% every year between 1998 and 2006. Yet major publications and almost all pundits missed the signs of impending disaster. More than seven million Americans lost their homes and millions more lost jobs. While it was a failure of fiduciary responsibility by the leaders of our banks and investment banks, I call it “criminal stupidity”. It is a crime against the employees and shareholders—blame is also shared by the rating agencies, Congress and others.
Politicians and financiers are now attempting to perpetrate another fraud—-the way they manage our public pension plans.
In 1995, as the newly elected state treasurer, I inherited the worst performing state pension plan in the nation—Connecticut. With over 68 money managers most of them unable to beat their benchmarks, we were two hundred basis points below the 49th state for the previous ten years. It was a pathetic confluence of politics and incompetence, and it meant that Connecticut left over $2 billion on the table if compared to if they had simply indexed the portfolio to 50% stocks and 50% bonds.
I run the Institute for Pension Fund Integrity, which recently completed a study of most of the states’ pension plans, and found that only five pension funds out-performed a benchmark of 60% stocks and 40% bonds for the previous ten years. In other words, instead of the hundreds of millions of dollars our states spend each year trying to “beat the market,” the vast majority waste those taxpayers’ dollars and employee contributions, and then compound it by failing to produce “alpha”: returns in excess of a reasonable benchmark.
Our politicians then continue the abuse by manipulating the way our funds calculate unfunded liabilities. They do this by failing to use up to date actuarial assumptions, excessively high assumed rate of earnings or returns, known as “ARR”, and then cover up the truth by not complying with the Government Accounting Standards Board (GASB) reporting standards for state and local governments. The current GASB 67 standards require plans to report their assets at market value, which shows actual market fluctuations, instead of actuarially smoothed value. However, public pension plans persist in using the “actuarially smoothed value for funding purposes because it exhibits less volatility” (Figure B1).
The Employee Retirement Income Security Act (ERISA), governs private-sector and Taft-Hartley pensions, and requires that plan managers use a market-driven ARR of between 3-5%. There is no equivalent requirement at the state level.
That means it’s up to the state legislatures and government agencies to determine an appropriate ARR. A higher ARR presumes higher profits on current investments. Using an ARR of around 7%—a level very few states can consistently earn above—means that unfunded liabilities are understated and the amount of money legislatures must annually appropriate during budget debates to their pension systems is reduced. In other words, it is a gimmick used by our politicians to kick the can down the road.
I have been on a 25-year crusade to keep political investing out of our public pension plans—when old pols like Mayor de Blasio in New York City want to impose their personal political agenda on investment decisions. I guess it did not help his campaign for president too much. In de Blasio’s case, he was trying to divest $5 billion in fossil fuel holdings from the city’s five public pension funds. I wonder: what fuel he was putting into the SUV that he was using to drive his kid to school?
Recently, the town of Charlottesville, Virginia voted to strip their holdings in companies that support our sons and daughters in our armed forces. As a retired Marine Corps infantry officer, I am particularly insulted by that one.
Another version of this politicizing is letting the two dominant proxy voting advisory firms—one owned by a Canadian holding company—making proxy voting decisions for our pension plans with little transparency to those of us who are beneficiaries of those plans. These firms advise pension plans on how to vote on a variety of corporate issues that impact returns, sometimes with a focus on “impact investing,” meaning they are also advocating for a specific political agenda—such as tobacco, or energy, or firearm manufacturers—-industries that have generated ire by some for political or social reasons.
The problem is that politicians and proxy advisory firms have no stake in how our public pension plans perform. They have no skin in the game. Our public plans, politicized, mismanaged and underfunded are a time bomb ticking away. The State of Connecticut owes me and my fellow pension beneficiaries at least $100 billion to our unfunded pension system. For California’s state pension system it is closer to $1 trillion. By choosing politics over fiduciary responsibility, the politicians have chosen to condemn our state and municipal employees to an insecure retirement, and to my fellow taxpayers, the prospect of huge increases in taxes to make up for their political malfeasance and stupidity.
Among the many solutions, it is time to take the politics out of the management of our public pension plans.