Public Pension Crisis: Blame the Lawmakers

November 8, 2013

Wall Street greed isn't to blame for the public pension crisis. In fact, fund officials are in a frantic search for high returns, having been led to a desperate state by politicians, says Caleb O. Brown, an adjunct fellow with the Competitive Enterprise Institute.

Wall Street wants to sell alternative investments to pension funds. And pension funds are often decidedly eager to invest. While the shift by public pension funds away from secure fixed income and into riskier investments accelerated after the financial crisis, it was actually decades in the making.

  • Between 1984 and 1994, U.S. public pension funds in total held just 5 percent of assets in alternatives and 50 percent in fixed income,reportsPensions and Investments.
  • By 2007, alternatives had doubled to comprise 10 percent of all pension fund holdings.
  • Since the financial crisis, alternatives have nearly doubled again to 19 percent of total assets.
  • By contrast, fixed income holdings have fallen nearly in half to 27 percent of total assets.

Clearly, pension funds have been chasing returns. Part of the cause is that politicians, during the reasonably good economic times before the financial crisis, were loath to make the full contributions recommended by actuaries -- the people who tell lawmakers how much to contribute to keep pensions funds functioning into perpetuity.

Unfortunately, pension fund managers and actuaries have been getting the accounting wrong for years. Many public pension plans discount their pension liabilities at high interest rates under the assumption that the plans will achieve high returns on their investments. Among economists, it is broadly agreed that 7 percent to 8 percent, the typical range of discount rates used by public pension plans, is inappropriate for a secure stream of payments.

The financial crisis was a contributing factor to a problem that would have existed anyway. That problem is lawmakers effectively telling pension fund managers that they need to aspire to get higher returns so fewer present state resources have to be devoted to fund generous pension promises. Unfortunately, as is often the case in politics, the potential for malfeasance arises anytime someone is allowed to avoid responsibility tomorrow for promises they make today.

Source: Caleb O. Brown, "The Real Reasons We Have a Public Pension Crisis," The American, October 23, 2013.

 

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