For the last several months, The New York Times has run a series of fascinating articles on the problems that poorly funded defined-benefit pension funds are encountering across the nation.
One of the more amusing articles was devoted to the investment results of two separate pension funds managed on behalf of the members of the Teamsters Union, which has long suffered from charges of rampant corruption. Well written by Mary Williams Walsh, the article described how one group of teamsters, whose fund was run by successors to the late Jimmy Hoffa, placed its money in investments like Las Vegas hotels, real estate and heaven knows what else. Retirees whose pensions were managed by this fund were quite secure.
Another group of teamsters had their pension assets managed by Wall Street firms like Morgan Stanley and Goldman Sachs. Sadly, these pensions were experiencing funding issues associated with poor investment results.
If much of the article‚s reporting was well done, its conclusions were questionable. Again and again throughout the series, equity investing was singled out as the reason behind all the problems these pensions are encountering. Why were money managers so dead set on investing pension funds in equities? According to The Times, it‚s because money managers can earn much more on equities than on fixed-income securities.
It‚s correct that management fees are higher for stocks than bonds. But while I‚m pretty cynical about the motivations of Wall Street, I think there are legitimate reasons why many leading academics, among others, have concluded that the optimal asset allocation mix for pension funds is 60% equities, 40% bonds, with tactical shifts of 10% to 20% either way from time to time based on market conditions.
First, as the Wharton School of Finance‚s Jeremy Siegel has demonstrated, bonds are more volatile than equities over the long term. Many of us, including some pension officers, forget that pensions are a long-term obligation. While the 2000-2002 bear market undoubtedly reduced the flexibility some pensions enjoy, proper stewardship could have avoided many of the current problems, most of which are self-inflicted.
These problems include: 1) excessive return assumptions of 9% or 10% prompting companies like IBM and General Motors to underfund their pensions, 2) the use of overfunded pensions to disguise weak operating earnings at companies like Lucent; 3) moves by corporate raiders like Carl Icahn and Ronald Perelman to virtually "loot" pension funds of their good assets and replace them with very-high-risk junk bonds; 4) absurdly generous benefits at companies like United Airlines where, according to one report, one flight attendant claimed she had earned a pension of $140,000 a year before her union was forced into accepting givebacks again and again.
Pensions are little more than promises and liabilities based on the good faith and credit of a company. When flight attendants are promised low seven-figure pensions, and top management is told theirs will be in the high six figures and CEOs get seven-figure annual payouts, why should anyone be shocked that companies either can‚t pay them and/or are forced into bankruptcy?
I‚ve worked at five different companies in my life, and none of them ever had a defined-benefit pension plan (several had 401(k) plans). For a long time, I felt rooked. After reading all these stories, I now feel lucky.
Opponents of privatizing Social Security are arguing that if professional pension funds can‚t succeed, what hope is there for individuals? Not much, assuming individuals engage in all the shenanigans the pros have.
While investing Social Security funds in equities might be problematic from an administrative viewpoint, privatizing this entitlement and letting individuals buy short- or intermediate-term government notes could enable people to earn modest 3% to 5% returns (far better than the Social Security trust fund), while helping the government finance its massive deficits. It would get the liability off Uncle Sam‚s books and give Americans a little more security. Right now they trust the government about as much as they trust Enron or United Airlines.
P.S. Please be sure to visit our redesigned Web site at www.fa-mag.com.
January 1, 2005