Tuesday, April 26, 2016

The Great Canadian Pension Heist?

Andrew Coyne of the National Post warns, Funding government projects through public pension plans a terrible idea:
The federal government, it is well known, is determined to spend $120 billion on infrastructure over the next 10 years. If traditional definitions of infrastructure are insufficient to get it to that sum, then by God it will come up with whole new definitions.

Ah, but whose money? From what source? The government would appear to have three alternatives. One, it can pay for it out of each year’s taxes. Two, it can borrow on private credit markets. Or three, it can finance capital projects like roads and bridges by charging the people who use them. Once these would have been known as user fees or road tolls; in the language of today’s technocrats, it’s called “asset monetization” or “asset recycling.”

Governments at every level and of every stripe have been showing increasing interest in this option, and with good reason. Pricing scarce resources encourages consumers to make more sparing use of them, while confining ambitious politicians and bureaucrats to providing services people actually want and are willing to pay for.

Moreover, by charging users where possible, scarce tax dollars are freed up to pay for the things that can only be paid for through taxes: public goods, like defence, policing and lighthouses.

Of course, if it is possible to charge users, it raises the question of whether the service need be provided, or at least financed, by the state at all. Rather than front the capital for a project themselves, governments can open it to private investors to finance, in return for some or all of the revenues expected to flow from it. As with user fees, this need not be limited to new ventures: “asset recycling” can also mean selling existing government enterprises — what used to be called “privatization.”

Again, there’s much to recommend this. If a project can be financed privately, it usually should, as this provides a truer measure of the cost of capital. (This point eludes many people: since the government has the best credit and pays the lowest interest rate, they ask, doesn’t it make sense to borrow on its account? But by that reasoning we should get the government to borrow on everybody’s behalf. If not, then it is privileging some investments over others, in the same way as if it were to directly subsidize them, and subject to the same critiques.)

The further removed from government, moreover, the less the chances of politicization. There’s a reason we set up Crown corporations at arm’s length from the government of the day, in the hopes of insulating them from politically-minded meddling.

Privatization simply takes that one step further. At the same time, a company in private hands can be regulated in a more disinterested fashion, without the inherent conflict of interest of a government, in effect, regulating itself. Last, experience teaches that when people own something directly, and have an interest in its value, they tend to take better care of it — whereas when the state owns something, no one does.

Yet government and private sector alike are too willing to blur this distinction. Rather than simply put a project out to private tender, with investors bearing all of the risk in return for all of the profit, public and private capital are frequently commingled. All too often, this means public risk for private profit.

That, alas, seems where we are headed — with an extra twist of malignancy. For, as the Canadian Press recently reported, the “private” investors the feds have their eyes on are in fact the country’s public pension plans, notably the Canada Pension Plan’s $283-billion investment fund and Quebec’s Caisse de dépot et placement — much as the Ontario government had earlier suggested it would use its planned provincial equivalent.

This is a truly terrible idea. On the one hand, it offers governments a way to finance their spending on the quiet, without subjecting their plans to the scrutiny of either the credit markets or Parliament. On the other hand, it opens pension funds to pressure to invest in ways that may not be in the best interest of pensioners, but rather of their political “partners.”

I know, I know: the public pension plans are independent of government, at arms’ length, and all that. But the history of the Caisse is rather less than reassuring in this regard, while the presence of the CEOs of both the Caisse and the CPP Investment Board on the Finance minister’s new economic advisory council does not quite scream independence.

Even more disquieting is the Caisse’s latest venture, a $5.5-billion light rail project in Montreal, of which the Caisse itself would put up a little more than half — with the remainder, it hopes, to come from the federal and provincial governments.

Is it too hard to imagine, in the negotiations to come, the governments in question suggesting a little quid pro quo: we’ll fund yours if you’ll fund ours?

Well now. If I lend you $100 and you lend me $100, are either of us $1 better off? Now suppose you and I are basically the same person, and you have some idea of the nonsense involved here. The pension plans will fund government infrastructure projects with the money they make on investments funded in part by governments out of the return on investments that were financed by the pension plans and so on ad infinitum.

A government that borrows from others acquires a liability, but a government that borrows from itself may be accounted a calamity.
Poor Andrew Coyne, he just doesn't get it. Before I rip into his idiotic comment, let's go over another equally idiotic comment by an economist called Martin Armstrong who put out a post, Asset Recycling – Robbing Pensions to Cover Govt. Costs:
We are facing a pension crisis, thanks to negative interest rates that have destroyed pension funds. Pension funds are a tempting pot of money that government cannot keep its hands out of. The federal government of Canada, for example, is looking to reduce the cost of government by shifting Canada’s mounting infrastructure costs to the private sector. They want to sell or lease stakes in major public assets such as highways, rail lines, and ports. In Canada, they hid a line in last month’s federal budget that revealed that the Liberals are considering making public assets available to non-government investors, such as public pension funds. They will sell the national infrastructure to pension funds, robbing them of the cash they have to fund themselves. This latest trick is being called “asset recycling,” which is simply a system designed to raise money for governments. This idea is surfacing in Europe as well as the United States, especially among cash-strapped states.

This is the other side of 2015.75; the peak in government (socialism). Everything from this point forward is a confirmation that these people are in crisis mode. They are rapidly destroying Western culture because they are simply crazy and the people who blindly vote for them are out of their minds. They are destroying the very fabric of society for they cannot see what they are doing nor where this all leads. Once they wipe out the security of the future, the government will crumble to dust to be swept away by history. We deserve what we blindly vote for.
Wow, "peak government socialism", "destroying the very fabric of society", and all this because our federal government had the foresight to approach Canada's big, boring public pension funds to invest in domestic infrastructure?

These comments are beyond idiotic. Forget about Martin Armstrong, he sounds like a total conspiratorial flake worried about the end of humanity as we know it (not surprised to see him publishing doom and gloom articles on Zero Hedge).

Let me focus on Andrew Coyne, the resident conservative commentator who also regularly appears on the CBC to discuss politics. People actually listen to Coyne, which makes him far more dangerous when he spreads complete rubbish like the article he penned above (to be fair, I prefer his political comments a lot more than his economic ones).

In my last comment on pensions bankrolling Canada's infrastructure, I praised the federal government's initiative of "asset recycling" and stated why it makes perfect sense for Canada's large pensions to invest in domestic infrastructure:
  • Federal, provincial and municipal governments are cash-strapped and they need funds to invest in infrastructure. Increasing taxes to do this is simply not a viable option when the economy is weak.
  • Unlike other investments, investing in infrastructure has huge long-term economic benefits to any country and infrastructure jobs pay well, which means there is an important multiplier effect to the overall economy from these jobs.
  • Pensions need yield. They can invest in public and private markets or in hedge funds. Increasingly, they're avoiding volatile public markets where bond yields are at historic lows and they're even starting to shun hedge funds which promise absolute returns but have failed to keep up with simple stock and bond indexes. 
  • Where are pensions turning to? Private equity, real estate and infrastructure. But unlike private equity, Canada's large pensions invest directly in infrastructure, avoiding hefty fees to general partners (GPs), and unlike real estate, the duration of infrastructure assets is a better match to the duration of their long dated liabilities which typically go out 75+ years. 
  • What else? infrastructure assets are highly scalable, meaning these large pensions can put a huge chunk of money to work in one infrastructure investment instead of many private equity or hedge funds which charge big fees and don't offer safe, predictable returns.
  • Most of Canada's large public pensions target an actuarial rate of 6.3% (nominal), so if Michael Sabia is right and infrastructure offers a stable, predictable and low-risk return of 7-9%, then why not invest directly in infrastructure? It makes perfect sense.
  • Canada's large public pensions are internationally renowned infrastructure investors, investing in airports, highways, ports, and other infrastructure investments all around the world. Their focus has mainly been in Britain and Australia where the rule of law is similar to the one in Canada. 
  • But if the federal government makes public infrastructure available to them here, either through long-term leases or outright sales, then why not invest in domestic projects, foregoing any currency risk or foreign regulatory risk? Again, it makes perfect sense, it's simple logic, not rocket science. 
  • Of course, if the federal government opens public infrastructure assets to Canada's large pensions, it has to do so for international mega pension and sovereign wealth funds too, introducing competition and leveling the playing field. 
  • Typically Canada's large pensions invest in mature infrastructure investments that have been operational for years and offer well-known cash flows, avoiding riskier greenfield projects with uncertain cash flow projections.
  • But the Caisse is dipping into greenfield projects here in Quebec. It can do so because it has hired an experienced team of infrastructure professionals with actual operational experience who have project management experience and have overseen previous greenfield projects.
I also stated the following:
No doubt, greenfield infrastructure projects carry bigger risks but they also offer bigger rewards down the road. Will everything go smoothly in this project? Of course not, there isn't one major greenfield infrastructure project that goes off without a hitch but the people working on this project have actual operational experience and a track record of delivering on such projects below budget (which isn't easy) easing my concerns about recouping operating and capital costs.

So, I would tell the media and critics to ease up and have faith in Macky Tall and his team at CDPQ Infra. They are all very experienced and highly ethical individuals who will deliver on this and other greenfield projects if they are asked to in the future. And trust me, there will be no Charboneau Commission on this project which is great news for Quebec's taxpayers.
Now, let's get back to Coyne's article. He states the following:
This is a truly terrible idea. On the one hand, it offers governments a way to finance their spending on the quiet, without subjecting their plans to the scrutiny of either the credit markets or Parliament. On the other hand, it opens pension funds to pressure to invest in ways that may not be in the best interest of pensioners, but rather of their political “partners.”
And follows up right away with this:
I know, I know: the public pension plans are independent of government, at arms’ length, and all that. But the history of the Caisse is rather less than reassuring in this regard, while the presence of the CEOs of both the Caisse and the CPP Investment Board on the Finance minister’s new economic advisory council does not quite scream independence.
First of all, it's arm's length, but leaving that typo aside, what is Coyne talking about? Canada's large public pensions have a fiduciary mandate to invest in the best interests of their beneficiaries by maximizing their return without taking undue risk. It is stipulated in the law governing their operations and it's part of their investment policy and philosophy.

Second, Canada's large public pensions operate at arm's length from the government precisely because they want to eliminate government interference in their investment process. Importantly, the federal government isn't forcing Canada's large public pensions to invest in infrastructure, it's consulting them to see if they can strike a mutually beneficial policy which will allow the government to deliver on its promise to invest in infrastructure and public pensions to meet their actuarial target rate of return by investing in domestic as opposed to foreign infrastructure (lest we forget their liabilities are in Canadian dollars and there is less regulatory risk investing in domestic infrastructure).

Here you have world class pension experts investing directly in infrastructure assets all around the world and Andrew Coyne thinks it's shady that Mark Wiseman and Michael Sabia are sitting on the Finance Minister's economic advisory council? If you ask me, our Finance Minister would be a fool if he didn't ask them and others (like Leo de Bever, AIMCo's former CEO and the godfather of investing in infrastructure) to sit on his advisory council.

In the height of the 2008 crisis, I was working as a senior economist at the Business Development Bank of Canada (BDC) and I clearly remember our team preparing that organization's former CEO, Jean-René Halde, for his Friday morning discussions with then Finance Minister Jim Flaherty. Other CEOs of major Crown corporations (like Steve Poloz the current Governor of the Bank of Canada who was the former CEO of Export Development Canada), were on that call too looking at ways to help banks provide credit and invest in small and medium sized enterprises. There was nothing shady about that, it was a very smart move on Flaherty's part.

Speaking of shady activity, I have more confidence in the people at the Caisse overseeing the $5.5 billion light rail project than I do with anyone working in the municipal, provincial or federal government in charge of our infrastructure assets. If you want to cut the risk of corruption, you are much better off having the tender offers go through CPDQ Infra than some government organization which isn't held accountable and doesn't have skin in the game.

That brings me to another topic. Canada's large public pensions aren't in the charity business, far from it. If they're investing in domestic infrastructure, it's because they see a fit to meet their long dated liabilities and make money off these investments. And let's be clear, they all want to make money taking the least risk possible because that is how they justify their hefty compensation.

The notion that any provincial or even the federal government is forcing public pensions to invest in infrastructure is not only ridiculous, it's downright laughable and shows complete ignorance on Coyne's part as to the governance at Canada's large public pensions and their investment mandate and incentive structure.

Andrew Coyne should stick to political commentaries. When it comes to public pensions and the economy, he's just as clueless as the hacks over at the Fraser Institute claiming CPP is too costly. It isn't, we should build on CPPIB's success.

By the way, if you want to see a really terrible idea, check out China's pension gamble. That is a perfect example of a country where there's no pension governance whatsoever (either you follow the government's instructions or your head is chopped off).

There's another bubble going on in China, a great ball of money rushing into commodities. Below, CNBC reports on how China just raised transaction costs to cool commodities frenzy. God help us!!

If I was Andrew Coyne, I'd be far more worried about Chinese speculating in the stock and commodities markets than Canada's large public pensions investing in domestic infrastructure. Then again, Coyne loves hearing himself speak even when he doesn't have a clue of what he's talking about.

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