My Rose Colored Glasses…Trends Issue – Global Pension Funds Crisis

MaryAnn Moore

For some of us the day we finally are able to retire and collect our pension check is a day that has longingly been looked for. But for many it may come as a rude shock to find it wasn’t what we had been promised, that somewhere along the way the secrets that had been swept under the rug, are now painfully out in the open. Most pension funds were never properly funded in the first place, and the financial collapse of 2008 has only made the predicament worse, often as a result of ‘funds in funds’ structured investing with little due diligence. The problem is coming to light as states, provinces, and municipalities are struggling to rectify their underwater budgets and have a limited ability to pay what they promised. U.S. state pension funds face an estimated shortfall of at least one trillion dollars for employees’ pensions and retirement benefits, according to the Pew Center on the States, with Illinois in the worst shape, with only 54% of its pension obligations funded. Over the last ten years , many states had shortchanged their pension plans in good times and bad. The Center’s director called the period of time as ‘a decade of irresponsibility’. In the U.S. there has been for some time a shift away from employer defined benefit programs to defined contribution programs to employee controlled, 401K type plans. With staffing cutbacks and early retirement in place, they are frequently faced with having more retired obligations than working ones. States are also mandated under their Balanced Budget Amendment to not spend more than their income, and requires a balance between revenues and expenditures. The legacy of unsustainability of entitlements and obligations versus the real economy has diverged to the point that a reconciliation of these two trends will be an explosive and difficult process. The Federal Government has tried to offset the budget pressures with the ARR Act and the State Fiscal Stabilization Fund, but these are running out, and the realities of Baby Boomers retiring have created a state budgetary crisis. Some 45 states and D.C. are projecting budget shortfalls for 2012.

The Republican ‘United States’ vs. America – Part One

Republican state such as Wisconsin, Ohio, and Indiana are considering or currently tabling legislation. Indiana has tabled legislation making it a Class A Misdemeanor for an employer to require an individual to become or continue as a member of a labour organization, or pay dues to such an organization. It would seem to be a challenge to both the blue collar worker, and the existing interpretation of the First Ammendment in regards to the ‘Right of Association‘, although the arguement is made around the ‘Right to Work‘. Democrats are trying to stall and stop this process where possible, with their power base long having been in the labour unions.

Pension Plans have had problems identified with their structure from the seventies. Anthropologists (O’Barr and Conely, ‘Fortune and Folly…’) have examined the process from a behavioural perspective and concluded the governance process was ‘culture bound, pseudoscientific, fawning in their relationship with outside service suppliers, blame deflecting, and generally ineffective’.  In 2003, Keith Ambachtsheer, using the CEM database found that the typical US pension fund carries six times as much policy risk as active managment risk, relative to it’s liabilities. He also stated that the worst errors can be traced to an industry-wide focus on maverick risk, as most work as agents, not principals, making it easier to fail conventionally, than succeed unconventionally.1.

In his book ‘Pension Revolution’ Ambachtsheer reviews a process which could transition pensions from what he labels as ‘fuzzy pension deals’ to ‘risk sharing co-ops’ and ‘the optimal pension system’ known as ‘TOPS‘. TOPS is to deal with the ‘human foibles issue’ by using auto-enrollment, and auto-pilot mechanisms that dynamically adjust individual contribution rates over time, and links optimal investment policy for each participant to their age. TOPS are to be run by arm’s length expert pension co-ops to minimize inherent conflicts, and the high cost that the run for the biggest profit financial service industry brings to the table. He envisions pension funds being run from the inside out, rather than by external agents from the outside for their own purposes.This format is already used in Australia and the Netherlands, where all workers are mandated to join, and by doing so are highly motivated to engage in reviewing processes, and building a better system. Even in Britain, the Turner Commission Report for the National Pension Savings Scheme advises for auto-enroll, with an opt out clause, and auto-pilot mechanisms for a life cycle investment approach, and to use retirement savings for life annuities. It recommended the structure of the NPSS as an arm’s length, expert pension co-op.

Canada, however, is looking at ‘pooled registered pension plans’ that is targeted for middle-income private sector workers and the self-employed. It is in essence a defined contribution Registered Pension Plan, with third party administration. The hope is that by pooling together plans, the group will benefit from lower investment management costs, improvements in fiduciary duty, and allow for portability. It is to be voluntary in membership.The concern is that its adds an additional burden to employers, along with the usual CPP deductions, and that ultimately it will result in a cut to employee pay.

Ireland has been hit very hard by both the collapse and partial recovery of the equity market in 2008, of which it’s pension fund was heavily weighed, and the stress of the it’s banking system failures. It had been predicted that up to 50% of pension funds in Ireland were set to collapse in 2009 without government intervention. Over 90% of pension plans in Ireland are of the defined benefit structure, and companies were looking at the option of declaring bankruptcy, to escape their obligations. The current coalition government between Fine Gael and Labour, is looking at what state assets to sell to deal with their financial crisis. The state is planning on issuing a sovereign annuity bond to Irish pension funds, that will provide a high yield, to help stabilize the situation somewhat. There is also consideration of issuing infrastruture bonds, rather than selling off state assets. However the bonds are designed, the problem they are trying to solve remains difficult.

Other European countries are examining the effect of raising the retirement age, on their obligations. There has been social protests over these changes in several countries, but these changes are minor, when compared to the actual effects of a plan bankruptcy, as what has happened in several companies and small cities in the U.S.

‘A Tale of Two Cities’

In Pritchard, Alabama, the city simply stopped paying pension checks. The pension fund was predicted to be out of money by July 2009, and the city filed for bankruptcy, but had it’s petition thrown out of court. Unfortunately for most of it’s pensioniers and contributors, Pritchard does not have the means to pay. It had been a city that peaked in the 1970’s at a population of 45,000, and now only has 27,000 residents and 144 retirees. The city has had chronic problems, and is in decline. In 1999 the city declared bankrutpcy when it’s finances were a mess, the pension fund had been in trouble at that time. The city ignored a court order to replenish the funds. In Setember 2009 Retired Fire Captain Alfred Arnold was 66, and his checks stopped. He was forced to return to work, which he found in Mobile Alabama as a security guard for a mall. The retirees had not been paid at that time (Feb 2011) for 17 months, and 14 retirees had died during that time period. Some of the retirees have stated that if there is no money for them, then there should be no money for city administrators also. Since that time, 2 more pensioners have died, one retired fire fighter died in a house without electricity, running water, heat or gas. There has been a proposal to offer the pensioners around 40% of their entitlement, and the city is still working on a solution.

Another city that has declared bankrupcy, Vallejo, California, is a city that contrasts sharply to Pritchard. It became, with a population of 121,000, the state’s largest city to declare bankruptcy in 2008. It had been rather lavish in pay, as compared to other cities in the state, for it’s public workers, and 74% of the cities annual budget was taken up by fire, police, and pension obligations. When it declared bankruptcy however, while it reduced some health benefits for retirees, it did not touch pension contributions. Retirees still enjoy their benefits although the police force has been markedly reduced, and the city cut funding for seniors and youth centers, arts organizations, and did little for business, even though the bankrupcy judge held the city ‘had authority to void its existing union contracts in an effort to reorganize’. Obviously, the city had a different perspective.

‘A Demographic Timebomb’

Much of the underlying beliefs, that facilitate ignoring the funding issue, have thoughts that reflect the live today, pay tomorrow, creed of our consumer culture, and feelings that the next generation will have to deal with it.What many Boomers have forgotten is that the generation following them is significantly smaller, much less affluent, and will be totally unable to fill the huge hole in funding. Boomers will not be able to retire in the style they are expecting to live in. In 2005, there was 5 workers in the U.S. to fund 1 retiree, and by 2030 there will only be 3 workers to fund 1 retiree. The chickens not only have come home to roost, but found there is no bar to rest on.

The U.S. Boomers are but the tip of the iceberg. U.S. Boomers will be the first of cohort of Worldwide Boomers retiring in the industrialized world, peaking around 2020. Canada will follow a few years later, as will the U.K. and Europe. The latter will have a longer lasting wave, and peaks around 2025-2030. China has a similar peak with population that will occur around 2050. Demographics are quite different for the industrialized and third world, with the third world having more of their population base in the youth demographic, reflecting a generally higher birth rate.

As the pension issue becomes a larger trend in various countries, states, and cities, it should be evident that we can set priorities that protect the most vulnerable and ease the way for the development of a better pension system than what currently exists, and does more then simply drop the ball on the individual, after other interests have failed.

‘Into the Frying Pan’ Update March 28 2011

In Wisconsin, legislative officials appear to be feeling the heat, and lashing out at the protests unions that have been mounting. Most recently, an email was sent to the Governor of Wisconsin by a deputy suggesting that he fake being physically attacked by a union member. Also, a tweet from the a deputy attorney general, who was fired shortly after as a result, proclaimed that live ammunition should be used on union demonstrators by police. Actions such as these will not endear this government to the public or unions, who already are angry, in fact these action may act as a catalyst, in galvanizing labour protests even further.

June Update

In Canada, workers went on strike with issues that involved pensions, for Air Canada it was the switch from defined benefits with their pensions, and for Canada Post, it involved a 3.2 billion dollar deficit with their plan. Both were being legislated back to work by the federal government. Protests continue in the U.S. and in other parts of the world trying to grapple with debt issues and restructuring.

1. May/June 2003 Editorial in the Financial Analysts Journal

‘Mourning, Money, and the Meaning of Life’ Trends Issue- The Evolution of Global Finance and the New Economy

The collapse of the Global Financial System 2008 – ongoing, was a rude shock to many people. As the global housing market imploded, the global banks imploded, global governments were rocked, and our societies are changing as well. For some an entire lifestyle has been up ended, and a new way of looking at the world has begun. There is even a new slang. The Jan 10, 2011 Urban Word of the Day was the phrase “When the economy picks up” which is described as a ‘common beginning or ending to a phrase’. This phrase ‘can provide and excuse for why one has not yet done something, or it can suggest a vague intention of doing something later, or it can add credibility to an idea that is a pipe dream’.

Several research papers have come to the conclusion that individuals that lost large amounts of money are close to 25% more likely to expect a crisis in the next 5 years compared to those who did not lose anything. This effect lasted for 12 yrs onward and the size of the loss correlated with the size of influenced expectations. The conclusion of this paper was that during a banking crisis, household losses have real and long lasting effects, and that these effects risk a long term drag on the economy. The financial collapse led us to realize how much of our economy was tied up in the FIRE sector. The bloating of the financial sector was a sign of unhealthy, unsustainable growth, that while politically advantageous to numerous administrations in various governments, was always a timebomb waiting to go off. The financial system, in many countries had grown too large. It ceased to be an means to an end, and became the end itself. In some ways it was a reflection of the change of values in society where money became our Gods. The stock market became a symbol of our success. When it fell in 2008, the hopes of many nations fell with it.

Many emergency measures were done to revive the patient, but the disease still remains. For a full recovery deep global financial reform must occur. In his book “The Stiglitz Report: Reforming the International Monetary and Financial Systems in the Wake of the Global Crisis” (Joseph E Stilglitz, 2010), Stiglitz described the conclusions that the UN Commission he headed.

“The crisis is not just a once in a century accident, something that just happens to the economy, something that could not be anticipated, let alone avoided. We believe that, to the contrary, the crisis is manmade: It was the result of mistakes by the private sector and misguided and failed policies of the public.” 

Stiglitz also chimes the mantra that ‘a better world is possible’ and quotes Ghandi’s vision, ‘where the fight for social and political change is not reducible to a fight between good and evil , but a struggle for Truth, in which each of us must take personal responsibility… Stiglitz however, has yet to outline how one can motivate all players in the financial sector to buy into the mantra of real change. Business has returned from those dark days in the fall, with some stimulus help, and everyone wants it to go back to the way it was. Procyclical overdrive policies forever! Some are starting to change. Compensation has been redesigned to reduce risk taking behaviours at some progressive firms, but more change is required on a global scale at a structural level. The evolution of the global financial system is still waiting to happen.

The general public meanwhile has a different take. They are often out of money, out of a job, and angry at their losses that they will not easily forget. The bubble economy that they were usually the last ones into, was forged by increasing demands for returns. Blowing up the bubble was favourable to many administrations. Procyclical policies plus, as the real economy stagnated. It had been overdrive into thin air. Informational asymmetries, as Stiglitz describes, favoured those who were told more. A global deluge in leverage blew the global asset bubble up and reality eventually threw in the needle. The problem was not the work of one man, nor many men, but an almost global belief that the financial market was itself a Godlike entity, that was ultra-efficient and self-correcting. How mortal it was, in the end.

Our understanding of money has changed. Money has become highly mobile and can exist in ‘flash markets’ that exist for only fleeting seconds. High frequency trading can buy and sell thousands of shares before you finish blinking. One can hold thousands of dollars in wealth one day, and have little the next day. The banks can be broke one day and recapitalised the next. Credit gave us what seemed to be an endless supply of money. What does money mean anymore? The Tofflers in their book ‘Revolutionary Wealth‘ speak of the rise of the ‘prosumer’ -those who produce what they consume, and of those who toil without pay in their economies, of a hidden nonmonetary economy. Will this nonmonetary economy enlarge in a time like this? Can the currently unemployed be reeducated for the information age or be engaged to volunteer in socially beneficial projects?
Stiglitz speaks of many global structural changes. Ones that take into account future issues such as global warming/climate change, rising food and energy costs, protecting developing countries, and trying to reduce poverty. He speaks of many countries who protect their economies with large reserves, which can contribute further to global imbalances, and of countries designing their stimulus with themselves in mind versus a global perspective. The various difficulties in coordinating tax codes with countries, never mind expanding the debt obligations of a country’s citizens for another country, is overviewed. Regulatory failure and the needs for global regulation, global courts, global economic governance are reviewed. Our global economy has far outgrown the ability to manage it.

One of the issues missing was a discussion on ‘resilience’ as a concept in designing a future global system. In our highly multi-linked world, should we think that even with all our planning and change-could collapse come again? What would be our final goal and associated contingencies for managing global imbalances? While we are making movements on developing new schools of economic thought, how do we deal with an undulating global economy? Do we compete always, or can we develop new ways of international co-operation that are not just back slapping.  The questions are numerous and unanswered.