The Blame Game?
While I empathize with the spirit of this article, Mr. Lerach fails to mention a few things. First, an agreement between the Clinton administration and congressional Republicans, reached during all-night negotiations on October 22, 1999 introduced the most sweeping banking deregulation bill in American history. It's simply wrong to blame "Conservatives" for deregulation of the American financial system. Both major parties catered to the financial elite to introduce sweeping banking deregulation.
The confrontations in Wisconsin and other states are the opening salvo of a political blame game -- who is responsible for the gigantic public pension fund deficits that threaten states' solvency and workers' retirement savings? The conservative spin machine blames public employees, claiming their greedy unions extorted extravagant and now unaffordable benefits which justify pension cutbacks and union-busting. This is a false. The real cause of the pension fund debacle is the greed of Wall Street and its corporate allies. It's a result of their dismantling of our nation's regulatory safeguards and Wall Street's capture and abuse of America's public pension funds -- charging them huge management fees, while losing trillions of dollars of pension fund assets in risky investments.
Wall Street developed with no regulation. Abuses abounded. Financial markets were corrupt. Then came the 1929 Crash, a wealth destruction event that ended the dreams of an American generation. The Pecora hearings exposed self-dealing and fraud by Wall Street bankers. Wall Street faced ruin. But instead of wiping out Wall Street or nationalizing the banks, we chose to save capitalism and protect investors -- by creating a new system of highly regulated financial markets.
Congress created the SEC to oversee stock exchanges, require honest accounting and disclosure by corporations and broke up (and strictly controlled) the Wall Street banks. In time, this new regulatory framework created the greatest age of economic growth and prosperity in history. Despite periodic recessions and bear markets -- there were no more investor wealth destruction events.
As the U.S. became the world's financial powerhouse, no one got more powerful than the Wall Street banks and their corporate allies. Then they set about undoing the very regulatory framework that had saved them. As politics came to depend on massive infusions of cash, no one provided more of it than corporations and Wall Street banks. They complained that regulation was restricting American competitiveness and economic growth -- our citizenry was seduced by promises of greater growth and prosperity. Government, which had actually been the key to the solution, became portrayed as the problem. They captured Congress. And then came the regulatory teardown.
Congress deregulated the S&Ls. Then it enacted severe cut backs on investor protections and curtailed their right to sue. Glass-Steagall was repealed -- allowing the long forbidden financial giants -- investment and commercial banks -- to recombine. The Wall Street/ Corporate alliance used its power to see that regulatory agencies passed into the hands of appointees who were hostile to the regulations they were supposed to enforce. Investor protection rules were diluted. A pro-corporate Supreme Court curtailed suits against banks and corporations. The result was behemoth banks, less regulatory oversight and less accountability.
So, what came from this era of de-regulation? Increased competitiveness, economic growth, wealth and prosperity? No -- instead we got repeated waves of financial fraud and wealth destruction events.
First came the S&L blowup of the mid-1980s. Over 3,000 S&Ls collapsed. A few years later it was the 2000-2001 dot.com/telecommunications meltdowns epitomized by WorldCom and Enron. Most recently, our major financial institutions were rocked by scandal -- the worst crash since 1929. Investors lost over $20 trillion in these three massive wealth destruction events, which were the result of the teardown of the regulatory framework that had been erected over the prior 70 years to control our financial markets and protect investors. America's public pension plans -- guardians of the life savings of countless working people -- were the biggest victims of these wealth destruction events.
A pension system is a bet on the future -- some money is set aside currently, but not enough to pay all the promised benefits. So, how pension funds are invested and safeguarded is key. Originally, many states required pension funds to invest in safe, interest-bearing bonds. But Wall Street could not make a lot of money from that, so it bank-rolled initiatives and legislation to repeal these protections and permit pension funds to be invested in the stuff they make big profits by peddling. Then Wall Street money managers captured pension funds' investment portfolios by assuring trustees that ever-higher stock prices would pay for the retirement promises. Charging enormous fees, they made risky stock market bets, putting up to 80% of pension plan assets in the stock market. The Wall Street wisdom that ever-rising stock prices would fund pension plan promises was wrong. In fact, we have seen three major equity wealth destruction events in last 20 years.
As a result, the financial situation of our public employee pension funds is precarious. These funds lost hundreds of billions in the S&L disaster and the 2001-2002 market crash. After the 2001-2002 wipeout -- guided by Wall Street -- fund trustees took much greater risks to try to make up for the prior losses. They poured billions into hedge funds, private equity, speculative real estate and that special Wall Street invention -- collateralized debt obligations. Then, in the 2008-2009 financial crisis, the losses of public funds were stupendous. 109 state funds lost $865 billion in about one year. CalPERS lost $72 billion! Now virtually all of these funds are now grossly under-funded. New Jersey and Illinois are each over $50 billion underwater.
Why are our public pension systems and plans in such precarious financial condition? Of course there are some examples of excessive pensions, of double-dipping and of "gaming" the system to "goose" the pension amount. But these are few in number. And, even in the aggregate, the financial impact of these excesses pale in comparison to the gigantic investment losses of these pension funds. So let's place the fault where it really belongs -- not with working people -- but with Wall Street banks. Who made money on these risky investment gambles? Who takes pension fund trustees to play golf and on so-called "educational" junkets at lush resorts to enjoy lavish dinners? Wall Street.
The inappropriate investments that caused these massive pension fund losses were not an accident. The pension fund field caught the Wall Street contagion -- financial corruption. It's called "Pay to Play." The SEC saw it years ago but, controlled by anti-regulation political appointees, it did nothing. So a nationwide system of political contributions to elected officials who sit on fund boards and payoffs and kickbacks to politically well-connected "Placement Agents" to steer fund money to Wall Street became widespread. Not surprisingly, the investments obtained by "pay-to-play" kickbacks and contributions have generated horrific losses.
An investment officer of the California Public Employee Pension Fund was forced to resign -- he got an all-expense-paid trip to NYC from an investment group that got $600 million from the fund. The middle men on that deal -- two former top CalPERs officials -- got some $20 million to arrange this placement. Two other former CalPERS officials have been sued by the Attorney General for taking $50 million in placement fees to steer pension investments. CalPERs lost hundreds of millions on such investments. Alan Hevesi -- the former head of the New York State Fund -- pleaded guilty to doling out billions in that Fund's assets to favored managers in return for benefits. The SEC has finally outlawed this system of bribes and kickbacks. But too late -- the damage has already been done to the pension funds. Nationwide, public pension funds lost billions on these types of corrupt investments with Wall Street types.
The horrible deficit numbers funds admit to actually hide a far more terrible reality. To determine how well a fund is "funded" it uses an assumed rate of return. It estimates how much the fund will earn on its investment portfolio in the future. For decades, public pension funds have assumed 7.5%-8%, even 9% annual growth, i.e., over 100% compounded over 10 years. Fat chance!
Today, pension funds are engaged in massive deceptions to conceal the true extent of their funding deficits. They are concealing the massive black holes that haunt public budgets. These ridiculous 7.5%-9.0% assumed rates of return are not "little white lies" -- they are Everest-sized whoppers. If the three big California Public Funds used a 4.5%-5% rate of return instead of the 7.5%-8% they now use, these funds would be $500 billion under-funded -- 10 times the $50 billion shortfall they admit to. Since this is a nationwide deception going on in virtually all public plans, try extrapolating that out. Public employee funds are probably $3 or $4 trillion underwater. The massive shortfalls we now face exist despite prior "Bull Markets" and the current rally. And the next round of excess of a still under-regulated Wall Street will produce another wealth destruction event that will erase recent gains.
This is no academic matter. The time to keep the retirement promises is now upon us. In the next several years, some 77 million U.S. baby boomers -- including millions of teachers and public service workers -- will enter retirement. Unfortunately, the U.S. public pension system has become a fraud-infested house of cards. Wisconsin shows us this house of cards is starting to collapse, sparking a major political battle.
The conservatives will "scapegoat" public employees as a privileged -- protected -- class. But it was not firemen, cops, clerks, or teachers (or their unions) who lost trillions of dollars in risky investments in an under-regulated stock market over the past 20 years. The Wall Street money managers lost it in investments acquiesced in by the pension fund trustees they had wined and dined. It's the same old story. The bankers pocket gigantic fees. The privileged few get fat. Ordinary people get run over. And now are even to be blamed -- even punished -- for a mess they did not create.
We cannot allow these public pension plans to collapse. Nor can we break our promises to workers who relied in good faith on promised pensions. Fortunately, there is a solution that could help protect retirees and at the same time help finance our huge federal deficit -- if we act fast.
These bonds will provide low-cost returns for pension funds. This will stop Wall Street's gouging the funds with huge fees and speculating with workers' retirement savings. This solution will also help finance our huge federal deficit. While the interest rate is high -- we taxpayers are going to end up paying to solve this problem one way or the other. And, at least this way, the interest payments will go to support our fellow retired citizens -- not the Chinese. It's a simple, elegant solution -- but Wall Street and the politicians they control will never permit it.
- First -- stop allowing Wall Street money managers to speculate with workers' retirement savings in risky equities and other crazy investments.
- Second -- create a new 7% or 8% inflation-indexed U.S. Treasury bond only for retirement funds, in staggered 10-30 year maturities. Require all pension plans to buy and hold these bonds. To allow an orderly transition -- require that over the next seven years -- 80%-90% of all pension plan assets must be put in these safe, high-yield bonds.
Second, as I wrote back in January, while a large part of the blame lies with Wall Street, it's too easy to use greedy bankers as scapegoats for the pensions fiasco. Poor governance, rosy investment assumptions, bad asset management (which didn't focus on protecting the downside) and bad political decisions all played a role too. Nobody forced pension fund managers to buy the crap Wall Street was aggressively peddling to them and other institutional investors. So many people fell for the utter nonsense that the Street was selling back then. They hired "rocket scientists" to slice and dice risky mortgage debt, turn it into "AAA" tranches which the rating agencies certified and presto, these investments became eligible for pension fund managers to invest in (sigh!). Anyone who's read Michael Lewis' The Big Short must be appalled at how pension fund managers totally abdicated their fiduciary duties by not questioning what was actually backing these "AAA" investments.
Third, while I like the idea of introducing more inflation-sensitive US Treasury bonds, I don't like the idea of forcing pension plans to invest the bulk of their assets in these bonds. This idea has been floating around for years (I believe Zvie Bodie came up with it), but it flies in the face of good governance and exercising fiduciary responsibility. There are no guarantees that inflation-sensitive bonds will outperform in the future, especially in a deflationary environment. That's why it's better to invest in a diversified portfolio of private and public markets.
Finally, as I mentioned in an update to my last comment on California pensions, there is a concerted effort going on right now to weaken public pension plans or abolish them altogether. I'm of the school of thought that this is pure fear mongering and total nonsense. While Wall Street continues to enjoy record bonuses, private and public pension plans are getting decimated. But instead of blaming people, we got to get on with it and start introducing meaningful regulations and reforms which will bolster pensions and the financial system.
The damage is done. We're not going to change the past, so let's focus on building the future. We can address the pension funds fiasco as responsible adults, recognizing that changes will require sacrifices from all stakeholders, or we can continue down this ridiculous path of public and private pensions attrition ensuring more pension poverty down the road. Keep this in mind as the political rhetoric on pensions heats up.