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The Next Catastrophe
Think Fannie Mae and Freddie Mac were a politicized financial disaster? Just wait until pension funds implode.
Jon Entine | February 2009 Print Edition
Funds worth trillions of dollars start to plummet in value. Political pressure to be socially responsible distorts the market decisions of government-related enterprises, leading to risky investments. Investors who once considered their retirements safely protectedwake up to a sinking feeling of uncertainty and gloom.
Sound like the great mortgage-fueled financial crisis of 2008? Sure. But it also describes a calamity likely to hit as soon as 2009. State, local, and private pension plans covering millions of government employees and union workers with defined benefit accounts are teetering on the brink of implosion, victims of both a sinking stock market and investment strategies influenced by political considerations.
From January to October 2008, defined benefit fundsthose promising a predetermined amount of retirement money to the payeeaveraged losses of 26 percent, according to Northern Trust Investment Risk and Analytical Services, making it the worst year on record for corporate and public pension funds. The largest public pension fund in the United States, the California Public Employees Retirement Security System (CalPERS), lost a staggering 20 percent of its value in just three months last year. In May 2008, Vallejo, California, became the largest city in the state ever to file for Chapter 9 bankruptcy, thanks largely to unmanageable pension obligations. The situation in San Diego looks worryingly similar. And corporations with defined benefit plans are seeking relief in Washington as part of a bailout season that shows no sign of slowing down.
If the stock market remains in a funk for even a few more months, corporations that oversee union pension funds and state and municipal leaders responsible for public retirement pools may be faced with difficult choices. First on the docket might be postponing cost-of-living increases and reducing health care coverage for retirees. Over the longer term, benefits for new employees will have to be shaved and everyone is likely to see an increase in personal payroll contributions. Corporations will have to resort to more cost cutting and layoffs of their own just to guarantee the solvency of their pension funds. And things could go from bad to terrible if the managers of those funds do not quickly revise their investment practices.
During melting markets, all pension funds come under siege. If youre covered by a defined contribution plan, contributions are invested, usually by your employer and usually in the stock market, and the returns are credited to the employees account. Your retirement savings grow if the market rises or, as is the case now, bleed when it crashes. You carry the risk on your shoulders.
The risk shifts to the employer under defined benefit plans, in which future outlays are guaranteed. That seemed like a great idea for business as recently as 2007, when the market was rising and the pension funds of Americas 500 largest companies held a surplus of $60 billion. Now theyre at a deficit of $200 billion, with fund assets dropping like a lodestone.
The Pension Protection Act of 2006 requires that companies keep the accounts fully funded over time, meaning that they have to have enough money to pay all of their retirees should they decide to withdraw their funds. Yet more than 200 of the 500 big-company plans are nowhere close to meeting that standard, and those dire numbers are increasing...
Just saying, something for the new administration to look forward to:
The Next Catastrophe: Think Fannie Mae and Freddie Mac were a politicized financial disaster? Just wait until pension funds implode. - Reason Magazine
