The aftermath of the 2008 financial crisis has obviously merited the reevaluation of any number of financial regulations, instruments, procedures, and the list goes on. Even in 2014 we are still sorting through a lot of the aftermath with toxic assets on peoples balance sheets still, but one of the most touchy subjects still today are the issues of pensions and their paper losses, sustainability, and how to regulate around them in the future.
So what are the stakes here? As you can see from the Fred Graph, pension assets have been steadily rising for as long as we can graph, at a rate much greater than that of GDP expansion.
Obviously these assets need to be protected in such a way that they are not so vulnerable in the next crisis and to do go about changing the way pensions work is a very touchy subject for people. There are different types of pension plans that companies can enroll into (as you will see this sounds eerily similar to the structure of CDO’s). Today the trouble exists with multi-company pension plans. What these plans do is pool the funds of many different companies and then invest them with the idea being that the fund managers will procure a rate of return that allows these plans to be self sufficient in perpetuity, all the while being able to withstand the economic downfalls of some companies due to the diversification that is achieved with so many different companies in the fund (NYTimes).
The same NYTimes article talks about how the CBO projects some of the largest pension plans, including that of the Teamsters, to run dry within the next seven years. Obviously this presents a major issue, one that could take down all of the insurance providers backing these pension plans as well. I have a feeling that Congress will have to write a check in order for most of these pensions to remain out of water, but courts are already cutting back on some of the pensions such as those supposed to be paid out to widows of workers that died before they were retired. The article references the fact that it has been illegal to cut benefits that have already been earned by workers, for over 40 years. There are plenty of tough decisions to be made here and plenty of people waiting to receive payment will find themselves rather disappointed in the future.
The question now needs to revolve around how the pension system can a) better hedge away risk and b) how they can avoid being stuck in a situation like this again in the future as we are still paying for the crashes in 2000 and 2008 today! As I alluded to, there are plenty of strong emotions surrounding this issue, but there needs to be a restructuring here.
The Laura and John Arnold Foundation is one of the leading institutes researching the health of these public pension plans and has publicly advocated for the conversion of many of these pension plans to quasi IRA’s or 401k’s or some other types of hybrid vehicles. What it comes down to though, is that the pension system, as it currently is, cannot be sustained due to the fact that there are more workers who work longer in our system (WSJ).
While many unions cry foul on the L&J Arnold proposals and have gone so far as to lobby those funding the foundation to stop spending money, they obviously cannot see the writing on the wall here. Even secured creditors can lose their money when there is none to pay out in bankruptcy cases, the same should go for these pensions. I think the main issue here need to be the education of the workers who are saving for retirement about the potential risks here and the fact that there is no such thing as a real risk free asset. If these people want to try and invest to achieve higher returns they should be able to select plans like that and do so at their own peril, rather than hiding behind insurance and pension plans. I am not saying that they do not deserve to get their money, rather, I would like to see people take a greater responsibility in educating themselves about whats going on with their money even if they are letting someone else manage it.
My second though here is similar to one that Prof. Kimball had on his blog in 2012, or at least takes a bit of a queue from it. The fact that all of these pension pools are invested in with a large number of companies does not really sound like that great of a hedge to me, or rather a complete hedge. I think that the investment managers need to be invested in countries outside of the United States or some other type of contra-asset, in order to further protect against potential economic downfalls. I realize that the world would tumble if the United States collapsed again, but I believe that having a large sample of companies is not enough to protect against economic downturns as is evidenced by the current state of pension plans.
All in all this really is the next big issue for the US to tackle and there is no one right answer. But I do emphasize yet again that I believe the holistic financial education of many of these workers is integral to the reduction in the information asymmetries that cause rapid moves in prices.