Why Public Pensions Can't Invest Safely - Some Lessons For All of Us
Public pensions can't invest safely any more - that is if they want to meet their obligations to their retirees.
Public pensions are pools of money set aside to fund promises made to public employees. Public employees include police, teachers, along with various other city and state employees. Many of these folks, after as little as 20 years, are entitled to lifetime pensions. The problem is, there's not enough money set aside to fulfill these promises.
The money that's there now won't be enough to fund the pension payouts promised in the future. How could this happen?
You would think that there would be some sort of oversight to make certain that the millions of people owed pensions would not be left high and dry, wouldn't you? Well, there is oversight. It's just not effective. Here's why.
First, you have to understand that the money in the accounts right now are used to pay out current retirees. So there's outflow. In addition, that same pool of money will be expected to be available to pay out future retirees. That's where things get tricky.
When these pension funds are audited, they provide the auditors with an expected or assumed rate of return. That's the amount they expect to earn on the money they have now. There lies the problem. The expected or assumed rate of return is unrealistic. Their assumptions are too high.
As an example, let's take a quick look at the three biggest public pensions in California: Calstrs, Calpers and UC Fund. These three, by the way are also three of the largest in the country. Each assumes the following rates of return: Calstrs - 8%; Calpers - 7.75%; UC Fund - 7.5%.
Recently a study produced by Stanford University criticized these funds and their assumed rates of return. The study says they're too high. The pension funds disagree.
I don't see how they can disagree. The only way they can claim their assumptions are valid is if they take inordinate risks with the pension money. And, of course, taking inordinate risks means the possibility, under certain circumstances, of losing substantial amounts of money - what is known as principal risk.
After all, you and I know that you don't get much return from things like money markets and bonds - two relatively plain and safe methods of investing. Money markets return somewhere around 1% (if you're lucky), bonds maybe average 4 - 6%. That leaves stocks and "alternatives" to stocks and bonds.
As for stocks, many of these funds already lost millions in 2008 on their stock investments. And their "alternative" investments, in many cases, also lost money.
Add to this the simple fact that people like Jeremy Grantham at GMO and Ed Easterling at Crestmont Research - both of whom have good track records in this area - predict that long-term stock returns should average less than 5%, in some cases negative returns, depending on the period of time you project.
The point is there's hardly much evidence out there that could justify the projections these folks are making.
Now, who knows, maybe they've concocted some scenarios, based on some risky bets they're prepared to make, that will provided those projected returns of 8%. What could they be? I certainly don't know.
So why would they make these outlandish claims? Because if they don't make them, then the public institutions - the universities, the public safety departments, and all the various city and state departments - would have to contribute more of the public's money to these pension promises. And, of course, the only way to get more of the public's money is to tax the public.
And the politicians who ultimately hire the executives who run these public pension pools really aren't going to appreciate being told they've got to tax their constituents even more than they're probably going to have to tax them as it is - given the huge budget shortfalls the cities and states now face.
Let's hope the people running these pension funds are simply lying about the returns they expect. The other choice is that they'll forget being prudent and start taking inordinate risks with this pension money - a pretty outrageous approach considering all the money they've already lost in 2008 with their relatively risky approaches.
As for the idea that they should simply invest safely and fund the public pension pools properly - even if it means raising taxes - you can pretty much forget that.
Public pensions are pools of money set aside to fund promises made to public employees. Public employees include police, teachers, along with various other city and state employees. Many of these folks, after as little as 20 years, are entitled to lifetime pensions. The problem is, there's not enough money set aside to fulfill these promises.
The money that's there now won't be enough to fund the pension payouts promised in the future. How could this happen?
You would think that there would be some sort of oversight to make certain that the millions of people owed pensions would not be left high and dry, wouldn't you? Well, there is oversight. It's just not effective. Here's why.
First, you have to understand that the money in the accounts right now are used to pay out current retirees. So there's outflow. In addition, that same pool of money will be expected to be available to pay out future retirees. That's where things get tricky.
When these pension funds are audited, they provide the auditors with an expected or assumed rate of return. That's the amount they expect to earn on the money they have now. There lies the problem. The expected or assumed rate of return is unrealistic. Their assumptions are too high.
As an example, let's take a quick look at the three biggest public pensions in California: Calstrs, Calpers and UC Fund. These three, by the way are also three of the largest in the country. Each assumes the following rates of return: Calstrs - 8%; Calpers - 7.75%; UC Fund - 7.5%.
Recently a study produced by Stanford University criticized these funds and their assumed rates of return. The study says they're too high. The pension funds disagree.
I don't see how they can disagree. The only way they can claim their assumptions are valid is if they take inordinate risks with the pension money. And, of course, taking inordinate risks means the possibility, under certain circumstances, of losing substantial amounts of money - what is known as principal risk.
After all, you and I know that you don't get much return from things like money markets and bonds - two relatively plain and safe methods of investing. Money markets return somewhere around 1% (if you're lucky), bonds maybe average 4 - 6%. That leaves stocks and "alternatives" to stocks and bonds.
As for stocks, many of these funds already lost millions in 2008 on their stock investments. And their "alternative" investments, in many cases, also lost money.
Add to this the simple fact that people like Jeremy Grantham at GMO and Ed Easterling at Crestmont Research - both of whom have good track records in this area - predict that long-term stock returns should average less than 5%, in some cases negative returns, depending on the period of time you project.
The point is there's hardly much evidence out there that could justify the projections these folks are making.
Now, who knows, maybe they've concocted some scenarios, based on some risky bets they're prepared to make, that will provided those projected returns of 8%. What could they be? I certainly don't know.
So why would they make these outlandish claims? Because if they don't make them, then the public institutions - the universities, the public safety departments, and all the various city and state departments - would have to contribute more of the public's money to these pension promises. And, of course, the only way to get more of the public's money is to tax the public.
And the politicians who ultimately hire the executives who run these public pension pools really aren't going to appreciate being told they've got to tax their constituents even more than they're probably going to have to tax them as it is - given the huge budget shortfalls the cities and states now face.
Let's hope the people running these pension funds are simply lying about the returns they expect. The other choice is that they'll forget being prudent and start taking inordinate risks with this pension money - a pretty outrageous approach considering all the money they've already lost in 2008 with their relatively risky approaches.
As for the idea that they should simply invest safely and fund the public pension pools properly - even if it means raising taxes - you can pretty much forget that.
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