We have an op-ed just published at Bloomberg, “How Your Pension Fund Became a Casino.” The article discusses changes to ERISA, the law that governs how retirement investments passed 40 years ago to professionalize the management of pension funds. Unfortunately, the Labor Department, which administers the law, reinterpreted some of its provisions in 1978 in responses to pressure from the financial services industry to allow pension funds to take greater risks. The piece explains how naive adoption of newer principles of investment, particularly modern portfolio theory, has blinded pension trustees to risks of entire types of complex investment, such as subprime securitizations and private equity, leading to losses and oversight failures.
I hope you’ll go read it pronto. I also wanted to thank the Bloomberg editor, Mark Whitehouse, who was a pleasure to work with. His revisions made the article much more accessible.
Hope you enjoy it!
29 comments
Comments are closed.
That all makes a lot of sense — but if you stop them now they’ll never climb out of the hole they’ve dug. Let’s get the 10-bagger first, then we can relax and think clearly. But now is not the most convenient time. The amount of money owed is incredible and strong measures are required if we want to accomplish our aims. There are several billion people on the planet with no income at all. They wander the earth like animals. If somehow they can access capital and spend it, that could be all we need to revive our original optimism and regain confidence in our theories. That should be our focus right now. How best to do that is an open question. Bombs and invasions probably aren’t the best tactic, since they breed resentment. Persuasion is the key, and artful diplomacy. It’s important to keep in mind who buys our meal ticket and avoid biting the hand feeds, if it’s well treated. Somehow that becomes an epiphany when it should be common sense. Then, when the heat is off, we can speak of the “mistakes that were made” with a suitable academic distance. Right now the circumstances are strained and uncomfortable.
Your words are so pragmatic. Would you like a Peace Prize? We have several here.
But it’s not like we didn’t see it coming. Our accounting was foretold, somewhere. “Climbing our of (our) hole” looks like an art form now. But I agree. Let’s not implode since we can use it all as a teachable moment in human evolution.
Gaia doesn’t give a shit about your 10-bagger and just because we are ignoring her warnings now doesn’t mean she won’t turn our existing social organization on its head with one mild fart.
The christian hubris that the earth is man’s to despoil is a key tenet of the capitalistic myth that has and continues to fuel “growth”. We keep getting closer to one or more physical aspect of our balancing act with our ecosphere not only being over the tipping point but affecting human survival. Climate/weather may be it.
But hey, are we sure, we are sure, we are sure, we are sure of humanity’s ability to be manipulated by a few to maintain this sick class structure and the empire it has built?
“Seduced by AAA ratings…..”
“Seduced by AAA ratings, fund managers often ignored the extraordinary complexity of mortgage securitizations, which typically involve hundreds of pages of documents defining the circumstances under which different investors get paid or suffer losses. As a result, they failed to notice some significant pitfalls.
For one, the contracts governing the securities gave an outsized, badly conflicted role to the mortgage servicer, responsible for interacting with borrowers and passing payments along to investors. Because the servicers were often the same banks that had made other loans to the borrowers, and because they could make more money by foreclosing than by fixing troubled loans, they had strong incentives to act against the investors’ (and the borrowers’) best interests.”
The evidence is overwhelming that servicers abused their powers”
==================================================
Shouldn’t that say “scammed, grifted, defrauded” their customers???? But of course, our incorruptible legal system investigated, prosecuted, and convicted the wrongdoers in short order
OUCH!!!! I hurt myself laughing…
Thanks for another well-written article. Glad to see some mainstream acceptance.
HA! did you choose that picture or was that one of bloomberg’s people?
You had me worried. There’s no picture. The only image is that from my Twitter feed, which I chose.
yikes, sorry. I was referring to the image above the article…
It was fun to click through to NC from Bloomberg :-)
Well done! Great article! Very comprehensive, substantial, and informative while also clear and easy to read!
Cheers! (I am enjoying sharing it around!)
Nice.
There’s nothing I could write over and above John Kay wrote on this http://www.johnkay.com/2014/07/09/trust-me-i-am-a-financial-adviser-is-not-good-enough
Although I’ll still post this quote:
‘The world was once simpler. A century ago, after one Mr Jackson, a stockbroker, sold dubious shares from his own portfolio to a Mr Armstrong, his client, he was taken to court. He faced the stern wrath of Sir Henry McCardie, the judge: “The prohibition of the law is absolute. It will not allow an agent to place himself in a situation which, under ordinary circumstances, would tempt a man to do what is not the best for his principal.” Jackson was ordered to make good all Armstrong’s losses.’
The trouble is the bastards have made the chain of ownership and the relation of the agent to the buyer so complex that they can evade such direct responsibility with ease. And, most importantly, our ethical standards have declined. Fifty years ago a firm that was discovered to be betting against its clients [shorting the products it was selling] would cease to have clients. Now, such sharp practices are admired and too many idiots say “I want those sharks working for me!” not realizing that they will never be working for you–they are exclusively out for themselves, and they view their reputations as irrelevant (something they could not do 50 years ago).
the comments at Bloomberg are fun to read!!
‘Erisa … created standards … that public pension funds … have also chosen to adopt.’
Went looking for more detail and found this from EBRI (Employee Benefit Research Institute):
Many sections of ERISA do apply to public-sector plans, including Title III and significant sections of Title II. Government plans are exempt from ERISA’s reporting, disclosure, and funding requirements (Title I) and plan termination insurance (Title IV).
While some observers continue to believe that state and local plans would benefit from the federal imposition of ERISA-like standards, state and local plans are financially sound.
http://www.ebri.org/pdf/publications/books/fundamentals/fund39.pdf
————
It’s the exemption from Erisa Title I requirements that allows deadbeat states such as IL and NJ to intentionally underfund their plans, and actors such as Calpers to play silly games with non-disclosure of PE investments.
The quoted passage seems to be from an earlier edition of EBRI’s Fundamentals of Employee Benefit Plans. As of the 6th edition in 2009, it was updated to read:
‘Some observers continue to believe that state and local plans would benefit from the federal imposition of ERISA-like standards. Underfunded plans can be found, although state and local public pension systems have traditionally been generally well financed.‘
http://www.ebri.org/pdf/publications/books/fundamentals/2009/43_RegCost_PUB-SCT_Funds-2009_EBRI.pdf
————
Well, isn’t that comforting! Doubtless EBRI’s 7th edition of Fundamentals will quote bankruptcy judge Steven Rhodes on Detroit’s plan:
“The state constitutional provisions prohibiting the impairment of contracts and pensions impose no constraint on the bankruptcy process.”
Erisa Title I coulda fixed that!
ERISA Title I defined benefit plans can go bankrupt, too! That’s what Title IV, the Pension Benefit Guaranty provisions, are all about. And the PBGC does not guarantee or cover all the benefits provided by all Title I pension plans–it only guarantees the level of benefits that it guarantees–so benefit promises often are impaired when the PBGC takes over a plan.
The California government code has a set of provisions that mimic (or mock) the ERISA Title I fiduciary responsibility provisions, giving the misleading impressionn that CalPERS, CalSTRS, and some city and county plans are administered by real fiduciaries.
Pension Funds have no requirement to feed and seed the next generation by rewarding firms that best extract the vast majority of productivity gains from the market, expecting future demand from the vacuum resulting.
Great that they published it. And Fool is right on. Love the Vegas image above the story.
Nice editorial Yves. You probably covered as much as you could with the space afforded, but the issue of corruption should also be addressed. The profits earned by parties to PE contracts, such as placement agents as well as partners cannot help but entice pension fund managers to accept risks they should not. I am no psychologist but I can see how a pension fund manager would feel “entitled” to capture some of those fees for themselves, either directly (kickbacks), or through the revolving door. Hence, the risk to the fund can become subordinate to the profits of the fund manager. While prosecutions help, removing such incentives would be better.
Congratulations! Good article. Comments are typical. Apart from a few, many seem to say that Pensions are a huge blight and should never ever happen and should be phased out STAT. Of course the happy happy fun fun answer is that everyone should just invest in the Ponzi Scheme called Wall Street, and then it’s all good.
One commenter did go so far as to snarl that some dumbf*cks might make “bad choices” and get ripped off (well, that’s MY terminology), but hey: sh*t happens and too bad so sad you’re poor, you deserve it you loser.
Even after the 2008 crash – which totally wiped out some people’s savings – these jerks have the nerve to state that 401 (k)s are the magical mythical ANSWER to all.
The original intent of 401(k) plans was to incentivize their beneficiaries to save a bit more of their own money. However, 401(k)’s were never intended to be a substitute for pensions, although that is what they’ve become.
Few would disagree on the need to expect people to take responsibility for their actions. However, it’s unrealistic to expect laypeople to match the returns that experts in the financial industry are able to achieve. Subsequently, the question becomes: what is a realistic level of personal responsibility we should expect of people?
I don’t know the exact answer to the question of what is a realistic level of personal responsibility but I don’t think it’s unfair to expect people to have some “skin in the game.” However, a dog-eat-dog, feeding everyone to wolves approach, leads us to where we are now: a substantial number of people, at or near retirement age, who simply can’t afford to retire. Some of members of this demographic will be able to make up the shortfall by working longer; however, there are many for whom the math doesn’t work out: i.e. working longer won’t be sufficient to make up the shortfall—at some point age-related health issues will force many to stop working. If you can’t afford to retire while you’re health, you’re probably ill-equipped to finance the costs of Long Term Care, so what happens to these people? Most likely, they’ll spend-down and rely on Medicaid for their Long-Term Care financing.
Yes there is the dog-eat dog mentality out there of “I got mine, to hell with everyone else.” However, when push comes to shove, how many people really want to see the elderly kicked to the curb? I doubt it’s very many, thus there is a collective moral obligation to provide some level of care, which means the question of retirement—in many ways—is a question of pay now or pay later: have some guaranteed payment system, even if it isn’t much, or end up paying later to keep people from becoming homeless and destitute.
Ultimately this question of pay or pay later with retirement is why privatizing Social Security, as some want to do, should give everyone pause: more likely than not will have, like the 401(k) disaster, a few people who do really well, and a large-number of people whose investments don’t pan out well and are inadequately prepared. The result is that we end up having spending significant amounts of taxpayer money—more than we probably would if Social Security is kept in its current form as a guaranteed payment—as a backstop to keep these people from being homeless and completely destitute.
re
However, it’s unrealistic to expect laypeople to match the returns that experts in the financial industry are able to achieve. Subsequently, the question becomes: what is a realistic level of personal responsibility we should expect of people?
Nonsense. ‘Experts’ able to achieve greater than passive index returns are very few and far between. The question becomes how much fiduciary/regulatory responsibility should we expect from investment advisors and investor protectors (i.e SEC and DOL).
Individual investors and pensioners are poised to be fleeced once again with a new wave of alternative investments ( read exotic toxic structured product) that the SEC has approved for retail distribution.
See http://www.bloomberg.com/news/2014-05-13/grandma-gets-to-play-hedge-fund-with-new-credit-swap-etfs.html if you want to get a small taste of what’s in store.The goal is to find a Pension fund+ retail replacement for AIG.
A recent Mckinsey report lays out, in very clear and gleeful language that the pickings are ripe for large asset managers to dump a few trillion $ worth of ‘alternative product on defined contribution plans who have no choice bit to invest , in Mckinsey’s own words, out of “desperation, not desire’ to attempt to meet their return targets.
Read it (and weep, or respond, or do something) here:
http://dailyalts.com/wp-content/uploads/2014/08/McKinsey-Company_2014_Capturing-the-Next-Wave-of-Growth-in-Alternative….pdf
Shame on the SEC for opening the floodgates to sales of risky debt to unwary retail investors.
Kudos to Yves for makin noise to draw attention to those charged with protecting pensioners.
The outdated ERISA standards are about to become even more outdated once marketing of this new wave of structured product gathers steam which McKinsey assures is a sure bet.
.
Your link disappeared. Do you have another one?
The URL has been truncated and broken by a software intervention. The consecutive dots are a tell.
Try this link
http://dailyalts.com/wp-content/uploads/2014/08/McKinsey-Company_2014_Capturing-the-Next-Wave-of-Growth-in-Alternative….pdf
If that doesn’t work then my tin hat meter says that McKinsey doesn’t want it widely distributed anymore,
“The original intent of 401(k) plans was to incentivize their beneficiaries to save a bit more of their own money. However, 401(k)’s were never intended to be a substitute for pensions, although that is what they’ve become.”
I’m curious, whose intent do you have in mind? Employers offered 401(k) plans precisely because they were an easy operational way to reduce total compensation (for average workers, of course), a general trend across wages and benefits. Virtually no new jobs have offered traditional pensions for a few decades now. And by the way, 401(k) plans are pension plans. They are defined contribution instead of defined benefit.
If employers were dumping $20K a year into 401(k) plans, no one would be complaining. It’s the amount of money, not the type of plan, that is the primary issue.
Are 401(k) plans “pension plans” or not? It depends on which set of ERISA jargon you are speaking.
Two types of “employee pension benefit plans” or “pension plans” regulated under Title I (Department of Labor provisions) of ERISA:
Type I: “individual account plans” or “defined contribution plans”–a plan in which the participant’s accrued benefit is stated as the balance of an individual account.
Type II: “defined benefit plan”–any pension plan which is not a “defined contribution plan.”
Title II of ERISA establishes the Internal Revenue Code tax qualification rules for this plans. Under these rules, the term “pension plan” covers all defined benefit plans as well as a type of defined contribution plan called a “money purchase plan”. The Title II provisions also cover other types of defined cocntribution plans called “stock bonus” plans and “profit-sharing” plans. (Employee stock ownership plans, or “ESOPs” are defined contribution plans that can be qualified as stock bonus plans.)
Section 401(k) plans are generally qualified as profit-sharing plans under Title II, although the employer stock match portion can be organized as a leveraged ESOP form of stock-bonus plans. So Section 401(k) plans are not “pension plans” under Title II terminology, though they are “pension plans” under Title I terminology.
Title IV of ERISA, the Pension Benefit Guaranty Corporation provisions, only apply to “defined benefit plans”, never to “defined contribution plans.” Therefore, there is no government-run guaranty fund to protect participants from any investment loss in value their 401(k) plan accounts.
Employers bear the risk of investment loss in defined benefit plans, which they must make good thorugh funding requirements as long as they maintain the plans, and they must also pay premiums to back up the PBGC guarntees that apply in bankruptcy. Dollar for benefit dollar, this makes defined benefit plans more costly and more risky for employers than defined contribution plans, which is why employers have been getting out of the defined benefit business since around 1984.
And then too: Enter Fukushima, WIPP, Hanford, etc; include maximum population and minimum energy; include the festering inherent conflicts among and between festering democracies; and don’t forget the ultimately self-serving financiers of the world. Not to mention global warming. Not to worry, as the Atlantic just implied, the worst may not happen for a century. Right. This point being that you cannot isolate gains and losses because they are all so interdependent.