A Forbes blogger has singled out Nashville's city pension for betting on risky "alternative" investments with this lurid headline:
Nashville Pension Bails on Bonds, Piles on Risk
Discounting at this rate is OK if we can earn 7.5% on our investments. That way, when the future finally gets here, we will have enough to pay off the pensions. However, if we earn less, then ...
Our city pension manager has put 15% of the pension fund into riskier investments to raise the return. A former student, who manages pension money, agrees with the blogger and thinks this is a risky idea:
Nashville Pension Bails on Bonds, Piles on Risk
If you participate in the Nashville pension, or are a taxpayer, I encourage you to pay attention to what’s going on in the investment portfolio. Rely upon your common sense and do not be swayed by financial alchemy. In my opinion, the Nashville public pension’s alternative fixed income and other gambles will, over time, prove to be ill-advised.I welcome this attention. Anyone who has read this blog, or chapter 5 of our text book, knows that I have been worried about Nashville' unfunded pension liabilities for quite some time. In fact, I was thrown out of a nice dinner party when I tried to "convince" the mayor that we should be discounting our future liabilities at a much lower rate than 7.5%.
Discounting at this rate is OK if we can earn 7.5% on our investments. That way, when the future finally gets here, we will have enough to pay off the pensions. However, if we earn less, then ...
Our city pension manager has put 15% of the pension fund into riskier investments to raise the return. A former student, who manages pension money, agrees with the blogger and thinks this is a risky idea:
...our independent investment advisors have recommended we invest no more than 7.5% of our portfolio in these types of "opportunistic" real estate funds (or any real estate funds).
Over a long enough horizon, the risk is supposed to average out. But that kind of thinking led to the complacency that played a role in the financial crisis.
Cross your fingers.
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ReplyDeleteAnything could happen!! Indicators look pretty stable at this point of time but they will show some serious ups and downs down the lane if we don't tackle it with proper wisdom. It require awesome display of pension mathematics.
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ReplyDeleteI worry that politicians will continue to get away with riskier financial decisions because people don't naturally think in longer time frames, the decisions and issues are difficult to understand, and there's so much gray area on who's at fault that politicians feel they can play hot potato with the blame whenever it lands. How can we, as politically concerned economists overcome all that stands against us?
ReplyDeleteI agree that short-term politics and local budgets are driving these long-term policies which will have negative impacts. But I also question the validity of pensions as a continuing retirement benefit for the masses. They're virtually non-existent in the private industry these days because businesses have realized that the funding required takes capital away from other necessary business projects. Additionally, there is no longer a patriarchal culture of working for a company for decades making the pension payout worth it. 401(k) and other DC plans allow for transportable benefits across organizations as careers migrate. I understand that this was a promised benefit in the past and there is value on following through on promises, but when are we going to reach of point of grandfathering these untenable plans and moving new employees onto DC plans which are more economically feasible?
ReplyDeleteI had these same thoughts the other day. Why do governments not realize the need to switch? I assume it has something to do with politicians needing/wanting the votes of those in public office and are simply afraid to make the necessary changes. Examples of poor leadership.
ReplyDeleteTo Justin & Mollie - You make some great points, but taking on public pensions is politically risky without immediate rewards. Pensions are like Social Security - the so-called "third rail of politics." Many elected leaders recognize the structural risks posed by unfunded liabilities, but lack the political will and/or ability to implement changes that will chip away at those liabilities. As a voting bloc, retirees make up a significant chunk - a fact not lost on those who run for office. Any elected official who tries to have a conversation about retirement changes - whether it's modifying benefits, tweaking COLAs, or (God forbid) transitioning from defined benefit to defined contribution plans - subject themselves to great political risks with, as I said earlier, no guarantee of immediate benefit (political OR financial - changes to retirement plans typically take years to really matter, or at least that's my personal experience with the issue).
ReplyDeleteTo Luke's point in the post - "Cross your fingers" is terrible public policy but not altogether uncommon, particularly on this issue. Increased public awareness is going to be key, and we've got to frame the issue not in terms of partisanship but simple math. To your point about discount rates - I've wondered what impact, if any, the new(ish) GASB standards will have on public pension awareness. As I appreciate it (and admittedly I need to better understand this), GASB is requiring states to report liabilities based on a more realistic discount rate, which may help highlight the financial exposure faced by some of these states (exposure that is currently masked by artificially high assumptions). FYI, the PEW Center on the States has done a lot of work in this area, as has the John Arnold Foundation, in terms of encoring more awareness and action on this issue by state legislatures.
Final comment - Some folks have suggested a federal government "bail out" for struggling retirement plans. I don't have all the answers but I do know that is NOT one of them!
Something the article does not touch on is the known risk that when interest rates are increased by the federal reserve, bond values will drop. Although cash flow from the bond coupons would remain the same, the pension fund value will drop. Hypothetically, by moving funds out of bonds and into equity, perhaps the fund will be able to ride out the rise in interest rates and later repurchase bonds at a lower price for the same cash flow. Not that I completely agree with this strategy, but I wonder if this played a role in the decision to find other investments.
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