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Pension Funds Continue Journey Towards Implosion November 27, 2005, 5:29 pm

Posted by quintapalus in Economics.

Well, this New York Times article doesn’t explicity say that, but the end result of this manoever has a high probability of ending up that way. The article details how more and more pension fund managers are investing larger shares of their monies in hedge funds.

For those not in the know, hedge funds are like the original version of day traders. They play fast and loose in a low to non-existent regulated environment. Many of the positions they take are very short term in nature as their idea is to move ahead of or contrary to the market to realize higher gains. The goal is like any investment vehicle, in that it is to make their clients money, but their real unpromisable promise, is to beat market no matter what and generate very high returns. It’s your typical high risk, high reward deal. It’s so risky, in fact, that some of the only rules surrounding them is the minimum level of investment. Hedge funds are pretty much an “only millionaires need apply.” The idea being that if you have this much money, you are smart enough to know the risks involved. It supposed to keep mom and dad middle America from being wooed by a 60% return of a certain fund and putting their $10K of hard earned money into it, only to lose it all. It’s kind of a condescending bit of regulation that totally shirks individual responsibility, but in this day and age, I guess I can understand. Now that we have that bit of background information out of the way, let’s get on to the story.

It’s should be no surprise that pension funds are in a bit of trouble these days. They have more pensioners than they ever predicted since people have become so inconsiderate that they actually are living longer these days. Much longer, in fact, than anyone ever thought when the benefits of these pension were originally defined. Now, add to that the health care benefits that these pensioners were also promised. It turns out that not only are people living longer, but it also costs a lot to keep them alive. Pensions are becoming a bigger and bigger drag on these companies than ever before and quel suprise they are being underfunded. Now comes the big decision, do the companies slash what they promised to their workers and pensioners or do they try to get a higher return on their pension funds to fill the gap. Well, some are doing both, but, as you might imagine, the unions have made it very difficult to restructure pension agreements. In light of the low interest rate environment we’ve seen over the past five years (which means bonds and other low risk investments have very crappy return rates), and the fact that the overall stock market hasn’t produced consistent gains during the same time frame, more and more of these companies are placing their futures in these hedge funds. Hopefully you are thinking what I was thinking as you read that: it’s sounds like a guy who has lost almost all of his money in a casino so instead of packing it in and going home, he gets even riskier trying to win it all back in one fell swoop, complete with return trips to the ATM.

Doesn’t seem very smart, eh? When you have to pay out on average 5% of your fund every year to meet your pension obligations, you can’t really afford to take a one year 20% loss. Or can you?

These pension fund managers are either really dumb or really smart, and I am betting on the latter. You see, for them, it’s win-win. If the pension fund manager choses the right fund and makes a windfall for his or her company, they come off as the big hero. If they strike out, well, turn that frown upside down, baby, for we live in the United States where no one ever gets stuck having to live with a bad decision, as long as you screw up big enough where it affects a lot of people. This is where the Pension Benefit Guaranty Corporation comes in. Created by the Employee Retirement Income Security Act in 1974, the PBGC acts as the ultimate guarantee that pensioners will not be left entirely in the lurch if things go into the toilet. The PBGC gets its money by charging a small premium to every company that pays a pension. In the event that a company defaults on its promises, the PBGC takes over and is in charge of paying those pensioners. Recently, this has become a tool used by large corporations saddled with unsustainable pension obligations. They can’t meet their obligations, so when restructuring talks between labor and management break down, as they almost always do, the board just says “fuck it; let’s declare bankruptcy, void our labor agreements, offload our pension to the Fed and emerge as a lean, mean fighting machine.” From a management point of view, it makes a lot of sense. It should come as no surprise that many companies are doing this (see United Airlines, Delta, American Airlines, etc etc) and it should come as no greater surprise that the PBGC is now running a yearly deficit having to pay out all of these assumed pensions. And guess who has to cover that? What’s that? You said the taxpayers? Well, give yourself some candy because you are absolutely correct, and let me tell you, this is going to make the Savings and Loan bailout look like chump change.

I am generally sorry for the individuals who worked for long periods of time for the same company that are seeing their retirement benefits cut, but I am looking forward to the day when the last defined benefit plan (i.e., the pension) is finally replaced by contribution plans like 401(k)’s and IRA’s. You can only count on the money being there when it’s YOUR money and under YOUR control. Anything less than that and you are relying on someone else to keep their promise and have your best interests in mind, always. Not a good gamble to make. Besides, when our companies have to compete in a global marketplace, they are much more competitive (and can pay their current work force better) when they don’t have to dedicate a certain portion of their profits to pay salaries to people who no longer work for them.

In summary, perhaps I should be in favor of pension funds being invested more heavily in hedge funds as that will most likely hasten their demise, but it’s just a crappy situation for everyone. It’s like rooting for your team to lose because if your team finishes last, at least that horrible head coach finally gets fired and your team can go in a new direction.



1. America…F*ck Yeah! » Reason 4,127 Why the American Auto Industry is in Trouble - January 22, 2006, 7:09 pm

[…] Think about that for a second. I can disagree, yet still understand, having to pay the 87,000 workers; they are operating under a mutually agreed upon contract. However, it’s the TWICE AS MANY retirees and dependents that Ford still has to take care of part (in terms of pensions and health care) that gets nuts. These are people that no longer contribute to any amount of the revenue that the company takes in, yet their benefits are taken right off the top. Now, I am not saying to throw these people under the bus, but who thought this was a good idea in the first place? And, with health care costs going up by double digit percentages every year, this problem is far from being at its worst. There is simply no way for Ford, or GM for that matter, to compete with companies that aren’t stuck with paying for huge amounts of people who no longer work for them. I have discussed at length previously why defined benefit plans (i.e., pensions) are horrible and that they should be phased out as soon as possible by employee contribution plans (i.e., 401(k)’s), but if there is any good that can come of this, it is that it will give us a good preview of what to expect in the main event of the fight card: Social Security and Medicare. […]

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