Thursday, May 21, 2015

Dealing With a World of Underinvestment?

Michael Spence, a Nobel laureate in economics and Professor of Economics at NYU’s Stern School of Business, wrote a comment for Project Syndicate, A World of Underinvestment:
When World War II ended 70 years ago, much of the world – including industrialized Europe, Japan, and other countries that had been occupied – was left geopolitically riven and burdened by heavy sovereign debt, with many major economies in ruins. One might have expected a long period of limited international cooperation, slow growth, high unemployment, and extreme privation, owing to countries’ limited capacity to finance their huge investment needs. But that is not what happened.

Instead, world leaders adopted a long-term perspective. They recognized that their countries’ debt-reduction prospects depended on nominal economic growth, and that their economic-growth prospects – not to mention continued peace – depended on a worldwide recovery. So they used – and even stretched – their balance sheets for investment, while opening themselves up to international trade, thereby helping to restore demand. The United States – which faced considerable public debt, but had lost little in the way of physical assets – naturally assumed a leadership role in this process.

Two features of the post-war economic recovery are striking. First, countries did not view their sovereign debt as a binding constraint, and instead pursued investment and potential growth. Second, they cooperated with one another on multiple fronts, and the countries with the strongest balance sheets bolstered investment elsewhere, crowding in private investment. The onset of the Cold War may have encouraged this approach. In any case, it was not every country for itself.

Today’s global economy bears striking similarities to the immediate post-war period: high unemployment, high and rising debt levels, and a global shortage of aggregate demand are constraining growth and generating deflationary pressures. And now, as then, the level and quality of investment have been consistently inadequate, with public spending on tangible and intangible capital – a critical factor in long-term growth – well below optimal levels for some time.

Of course, there are also new challenges. The dynamics of income distribution have shifted adversely in recent decades, impeding consensus on economic policy. And aging populations – a result of rising longevity and declining fertility – are putting pressure on public finances.


Nonetheless, the ingredients of an effective strategy to spur economic growth and employment are similar: available balance sheets (sovereign and private) should be used to generate additional demand and boost public investment, even if it results in greater leverage. Recent IMF research suggests that, given excess capacity, governments would probably benefit from substantial short-run multipliers. More important, the focus on investment would improve prospects for long-term sustainable growth, which would enable governments and households to pursue responsible deleveraging.

Likewise, international cooperation is just as critical to success today as it was 70 years ago. Because the balance sheets (public, quasi-public, and private) with the capacity to invest are not uniformly distributed around the world, a determined global effort – which includes an important role for multilateral financial institutions – is needed to clear clogged intermediation channels.

There is plenty of incentive for countries to collaborate, rather than using trade, finance, monetary policy, public-sector purchasing, tax policy, or other levers to undermine one another. After all, given the connectedness that characterizes today’s globalized financial and economic systems, a full recovery anywhere is virtually impossible without a broad-based recovery nearly everywhere.

Yet, for the most part, limited cooperation has been the world’s chosen course in recent years, with countries believing not only that they must fend for themselves, but also that their debt levels impose a hard constraint on growth-generating investment. The resulting underinvestment and depreciation of the global economy’s asset base are suppressing productivity growth and thus undermining sustainable recoveries.

In the absence of a vigorous international re-investment program, monetary policy is being used to prop up growth. But monetary policy typically focuses on domestic recovery. And, though unconventional measures have reduced financial instability, their effectiveness in countering widespread deflationary pressures or restoring growth remains dubious.

Meanwhile, savers are being repressed, asset prices distorted, and incentives to maintain or even increase leverage enhanced. Competitive devaluations, even if they are not policymakers’ stated objectives, are becoming increasingly tempting – though they will not solve the aggregate-demand problem.

This is not to say that sudden “normalization” of monetary policy is a good idea. But, if large-scale investment and reform programs were initiated as complements to unconventional monetary-policy measures, the economy could move onto a more resilient growth path.


Despite its obvious benefits, such a coordinated international approach remains elusive. Though trade and investment agreements are being negotiated, they are increasingly regional in scope. Meanwhile, the multilateral trade system is fragmenting, along with the consensus that created it.

Given the level of interconnectedness and interdependence that characterizes today’s global economy, the reluctance to cooperate is difficult to comprehend. One problem seems to be conditionality, with countries unwilling to commit to complementary fiscal and structural reforms. This is especially evident in Europe, where it is argued, with some justification, that, without such reforms, growth will remain anemic, sustaining or even exacerbating fiscal constraints.

But if conditionality is so important, why didn’t it prevent cooperation 70 years ago? Perhaps the idea that severely damaged economies, with limited prospects for independent recoveries, would pass up the opportunity that international cooperation presented was implausible. Maybe it still is. If so, creating a similar opportunity today could change the incentives, trigger the required complementary reforms, and put the global economy on course to a stronger long-term recovery.
This is an excellent comment from an economist that understands the true nature of the crisis today.

Importantly, the world is awash in debt and liquidity but unless policymakers figure out a way to take advantage of historic low bond yields to invest and deal with unacceptably high chronic unemployment in the developed world, then deflationary pressures will persist and haunt us for a very long time.

Go back to read my comment on whether global reflation is headed our way where I wrote the following:
Global deflation is not going to happen? Really? That's news to me because I keep warning my readers to prepare for global deflation or risk getting slaughtered in the years ahead.

Let's go over a few things which I think are confusing people. First, the euro deflation crisis is far from over. The fall in the euro temporarily boosted import prices and inflation expectations in the eurozone but the underlying structural issues plaguing its economies have not been addressed.

Unless you have a significant pickup in eurozone employment and wages, you can forget about any reflation in that region. The ECB will keep pumping trillions into banks but unlike the Federal Reserve, it's limited in what it can buy in its bond purchases.

Then there is Greece. The latest payment plan is just a shell game. The Greek disconnect is alive and well and threatens not only the eurozone but the entire global financial system through contagion risks we're unaware of and by extension, the entire global economy.

But even if they find a solution to this ongoing Greek saga, there are other far more important worries out there. The China bubble is my biggest concern right now. According to a senior Morgan Stanley investment strategist, the worst of the Chinese economic slowdown is likely still ahead because of the nation's debt:
"China, to try and sustain its growth rate in the post-financial-crisis era, has engaged in the largest credit binge of any emerging market in history," said Ruchir Sharma, head of emerging markets and global macro at Morgan Stanley Investment Management,

Sharma, speaking Tuesday at the Global Private Equity Conference in Washington, D.C., predicted that the credit boom would cause problems.

Whenever a country increases its debt to gross domestic product sharply over five years, in the next five years there's a 70 percent chance of a financial crisis and 100 percent chance of a major economic slowdown, according to Morgan Stanley research.

The Chinese government this week cut interest rates for the third time in six months because of projected 7 percent GDP growth this year, the lowest level in more than two decades.

Sharma said the slow growth he forecast would be around 4 percent or 5 percent over the next five years, about half the rate of what it used to be.

"If China follows this template, it really is payback time," he said.

Another speaker at the conference, former U.S. Gen. Wesley Clark, took a less grim view.

"I'm not as worried about the buildup of debt in China as other countries," the founder of Wesley Clark & Associates said.

He cited two reasons. The renminbi is not fully convertible to other currencies, and the Chinese economy still has elements of central control.

"Every year people at these business conferences say the demise of the Chinese economy is coming very rapidly," Clark added. "But it hasn't happened. And President Xi is not going to let it happen if he can avoid it."

Another China bull, Robert Petty, managing partner and co-founder of Clearwater Capital Partners, said China can forestall its debt problems.

"We believe the balance sheet of China absolutely has the capacity to do two things: term it out and kick the can down the road," Petty said.
It remains to be seen how Chinese authorities will forestall or mitigate  the inevitable slowdown but if it's a severe slowdown, watch out, we're going to have more deflationary pressures heading our way (any significant decline in the renminbi will mean much lower goods prices for the developed world since we pretty much import most of our goods from China).

The demographics of China and Japan are also scary. China is sliding into a pensions black hole and Japan isn't doing that much better. Some of the same structural issues plaguing the eurozone -- older demographics in particular -- are plaguing China and Japan.

So if China slows down considerably in the years ahead and Abenomics fails to deliver in Japan, where is global growth going to come from? Europe? Nope. BRICS? Apart from India, the BRICS are weak and getting weaker, not stronger. Russia is trying to hold on for its dear petro life and Brazil isn't going anywhere as China slows down.

Then there is America, the last bastion of hope! U.S. job growth rebounded last month and the unemployment rate dropped to a near seven-year low of 5.4 percent, but there's still plenty of slack in the economy with the number of Americans not in the labor force rising to a record 93.2 million (most of these long-term unemployed are women). Moreover, America's risky recovery poses serious challenges to the global economy, especially if the Fed makes a monumental mistake and starts raising rates too soon and too aggressively.
On Wednesday, Jeff Cox of CNBC reported that 40 percent of unemployed have quit looking for jobs:
At a time when 8.5 million Americans still don't have jobs, some 40 percent have given up even looking.

The revelation, contained in a new survey Wednesday showing how much work needs to be done yet in the U.S. labor market, comes as the labor force participation rate remains mired near 37-year lows.

A tight jobs market, the skills gap between what employers want and what prospective employees have to offer, and a benefits program that, while curtailed from its recession level, still remains obliging have combined to keep workers on the sidelines, according to a Harris poll of 1,553 working-age Americans conducted for Express Employment Professionals.

On the bright side, the number is actually better than 2014, the survey's inaugural year, when 47 percent of the jobless said they had given up.

"This survey shows that some of the troubling trends we observed last year are continuing," Bob Funk, CEO of Express Employment Professionals and a former chairman of the Federal Reserve Bank of Kansas City, said in a statement. "While the economy is indeed getting better for some, for others who have been unemployed long term, they are increasingly being left behind."

Duration matters: The longer someone was out of work, the more likely it is that they've quit looking.

Of the total, 55 percent who were unemployed for more than two years fell into the category; 32 percent of those idle for 13 to 24 months and 34 percent out for seven to 12 months had quit as well. Just 21 percent out for three months or less had stopped looking.

Overall, nearly 1 in 5 (19 percent) said they spent no time looking for work in the week previous to the survey. Just 10 percent said they spent more than 31 hours looking.

Unemployment compensation also matters.

Federal guidelines allow for 26 weeks of unemployment compensation, though extended benefits are available in some circumstances.

Nearly 9 of out 10 respondents (89 percent) said they would "search harder and wider" for work if their benefits ran out. Moreover, in a series of statements about benefits, the one that garnered the most agreement, with 69 percent, was that benefits were "giving me a cushion so that I can take my time in searching for a job," while 59 percent said compensation "has allowed me to take time for myself," 36 percent agreed that it "has allowed me to turn down positions that weren't right for me" and 40 percent agreed "I haven't had to look for work as hard knowing I have some income to rely on."

Of those out of work and not receiving benefits—those who have quit looking are not eligible—22 percent said their benefits had run out and 32 percent said they weren't eligible.

The decline in labor force participation, in fact, has been a key to the drop of the unemployment rate in the post-recession economy. The jobless rate has slid from a high of 10 percent in October 2009 to its current 5.4 percent, the lowest level since May 2008. However, the participation rate has fallen from 66.1 percent to 62.8 percent during the same period.

Benefit programs have expanded as well, even as unemployment compensation dropped from the 99 weeks of eligibility during when the jobless rate was much higher.

The Supplemental Nutrition Assistance Program—food stamps—now serves 45.7 million Americans, down from nearly 48 million in 2012.

"Over the last year, we have seen the unemployment rate go down, but we too easily forget that there are people still hurting, still wanting to work, but on the verge of giving up," Express Employment's Funk said. "I believe everyone who wants to work should have a job, so we must not overlook those who have been left behind and left out of the job market."
I know all about chronic unemployment and discrimination, and vent on my blog from time to time (like here, here and here) because nothing is more incredibly frustrating than applying to jobs you're eminently qualified for only to get shut out because of political or discriminatory reasons.

But I dealt with unemployment by taking matters into my own hands, effectively creating my own job. I started this blog in 2008 and built it up one comment at a time to be one of the most read blogs on pensions and investments. I turn some people off sometimes but that's alright, I'm not writing this blog to win a popularity contest nor are they living my life to fully appreciate what I've lived through or where I'm coming from. Some people have helped me financially but nobody has offered me a job.

Anyways, chronic unemployment is an issue. Companies don't like hiring people who have been out of a job for a long time because they think their skill set has been eroded and they have nothing to offer. In some cases, this may be true, but in others it's blatantly false. In all cases, these are human beings who deserve an opportunity to work and provide for themselves and their family.

And what happens to all these chronically unemployed people when they're out of  a job for such a long time? They end up on social assistance, collecting food stamps to survive. This is the reality for millions of Americans living in the United States of Pension Poverty.

This is why when people get all excited about an improving labor market, I can't help but point out any improvement that doesn't improve the lives of millions of chronically unemployed is simply a chimera, an illusion that neglects the gravity and reality of how bad the situation really is.

Getting back to Michael Spence's comment, he points to rising inequality but fails to make the following connection. Rising inequality, the ongoing jobs crisis, the ongoing retirement crisis, the aging of the population, are all extremely deflationary factors. Spence alludes to it but doesn't delve into these topics.

But his call for boosting investment to boost aggregate demand is right on and I think public pensions can play an important role in this regard. Go read my comment on opening Canada's infrastructure floodgates where I wrote the following:
No doubt about it, Canada's large pensions can play an integral role in funding domestic infrastructure but they have to maintain their arms-length approach in making such investments and not be forced to invest in these projects by any government. 

All of Canada's large pensions are shifting huge assets into infrastructure as they look for very long-term investments with steady cash flows offering them returns between equities and bonds. Infrastructure investments are an integral part of asset-liability management at pensions which typically pay out liabilities over the next 75+ years (the duration of infrastructure assets fits better with the duration of the liabilities of these plans).

The problem right now is there aren't enough domestic opportunities so our large pensions are forced to invest in infrastructure projects abroad. This introduces legal, regulatory, political and currency risks (their liabilities are in Canadian dollars). For example, PSP's big stake in Athens airport makes perfect long-term sense but if Greece defaults and exits the euro, all hell can break loose and the leftist or worse, a junta government, might nationalize this airport. Even if they don't nationalize, if they reintroduce the drachma, it will significantly damper PSP's revenues from this project.

As far as incorporating models from Australia and the UK, I think Australia has got it mostly right. They privatized their airports and ports and Canada needs to do the same to fund other projects. The UK's experience with the Pensions Infrastructure Platform has its share of critics but there have been some big deals there too.

Whatever the Liberals decide to do, their initiative needs to entice foreign pension and sovereign wealth funds as well. It won't be enough to have Canada's large pensions on board. And as I stated above, our governments will still need to invest billions in domestic infrastructure.

From an economic policy perspective, massive investments in infrastructure are needed especially now that Canada is on the precipice of a major crisis. We're living in Dreamland up here and I fear the worst as Canadians take on ever more crushing debt. The country desperately needs good paying jobs, the type of jobs massive infrastructure projects can provide.
We need as a society to start taking the long, long view on public investments, jobs and pensions. If we don't, we are doomed to repeat the same mistakes of the past. Central banks can keep on printing but that won't address deep structural issues plaguing our economies, rising inequality and chronic unemployment being the two most worrying trends.

Below, digging into soft economic data, and what is signals about employment, with Joe LaVorgna, Deutsche Bank chief economist, and CNBC's Steve Liesman.

Also, the cataclysmic gold bugs over at Zero Edge posted an older clip of Bridgewater's Ray Dalio slamming Buffett and touting gold, but I was more interesting in this comment: "we're beyond the point of being able to successfully manage this... and I worry about another leg down in the economy causing social disruption... Hitler came to power in 1933 because of the social tension between the factions."

I hope Ray is wrong about that. On Friday, I will peek into the portfolios of top funds, including Bridgewater and show you what they bought and sold last quarter.

Also, let me end by plugging an ebook my friend Brian Romanchuk just completed, Understanding Government Finance. Brian sent me an advanced copy and it's a superbly written book which explains Modern Monetary Theory (MMT) and a lot more in very clear language.

I highly recommend all of you, including Ray Dalio, take the time to read it and understand the points Brian is advancing on debt and deficits. I embedded a clip of Warren Mosler, one of the fathers of MMT, where he explains the tenets of this theory in clear language. Listen carefully to this interview.



Wednesday, May 20, 2015

Wynne’s Pension Boondoggle?

Lorrie Goldstein of the Toronto Sun reports, Wynne’s pension boondoggle?:
Suppose Premier Kathleen Wynne’s Liberal government forced you into its Ontario Retirement Pension Plan (ORPP) and took 1.9% of your earnings up to a maximum of $1,643 annually for your entire working life.

Suppose it invested this money into poorly-run, money-losing Ontario public infrastructure projects, in which the government partnered with private companies and lost its shirt -- and thus your future pension benefits.

Based on the scant information the Liberals are giving out in preparing to implement their ORPP on Jan. 1, 2017, that could happen. Here’s why.

In Finance Minister Charles Sousa’s 2014 budget, here’s how the Liberals explained how they will invest over $3.5 billion annually in mandatory pension contributions.

These will come from more than three million Ontario workers who will be forced into the ORPP because they do not have private pension plans, and from their employers.

(The ORPP will be funded by a 1.9% annual payroll tax imposed on these workers, plus an additional 1.9% annual tax for each employee, paid by their employers.)

“By ... encouraging more Canadians to save through a proposed new Ontario Retirement Pension Plan, new pools of capital would be available for Ontario-based projects such as building roads, bridges and new transit,” the Liberals said.

“Our strong Alternative Financing and Procurement model, run by Infrastructure Ontario, will allow for the efficient deployment of this capital in job-creating projects.”

Really? First, the purpose of the ORPP should not be to help the Liberals fund infrastructure because they’re broke and can’t get the money elsewhere, other than by holding a fire sale of provincial assets like Hydro One, which they’re already doing.

The only purpose of the ORPP -- similar to the stated one of the Canada Pension Plan (CPP) -- should be to “maximize returns (to contributors) without undue risk of loss.”

To do that, the Canada Pension Plan Investment Board (CPPIB), which invests mandatory contributions on behalf of working Canadians so the plan will have the funds to pay them a pension upon retirement, operates independently of the federal and provincial governments.

As the CPPIB says in its 2014 annual report:

“As outlined in the CPPIB Act, the assets we manage ($219.1 billion) belong to the (18 million) Canadian contributors and beneficiaries who participate in the Canada Pension Plan. “These assets are strictly segregated from government funds.

“The CPPIB Act has safeguards against any political interference (operating) at arm’s length from federal and provincial governments with the oversight of an independent ... Board of Directors. CPPIB management reports not to governments, but to the CPPIB Board of Directors.”

To be sure, the CPPIB has been criticized over everything from its administrative costs, to the bonuses it pays to senior executives, to the wisdom of some of its investment decisions.

But on the key issue of how it is run, politicians, by law, aren’t allowed to interfere in its investment decisions, for obvious reasons.

By contrast, the Wynne government is sending contradictory messages about how investments needed to ensure its solvency will be decided by the ORPP.

On the one hand, Sousa says, “our plan would build on the strengths of the CPP ... publicly administered at arm’s length ... (and) have a strong governance model, with experts responsible for managing its investments.”

But on the other, the Liberals want a substantial amount of the funds raised by the ORPP to go to “new pools of capital” for “Ontario-based” infrastructure projects.

These are contradictory statements.

Either the ORPP investment board will be independent in its investment decisions, or it will be ordered, or influenced, by the Wynne government to make investments in Ontario infrastructure projects the government wants to build.

As for the Liberals’ claim their, “strong Alternative Financing and Procurement model, run by Infrastructure Ontario, will allow for the efficient deployment of this capital in job-creating projects”, Ontario Auditor General Bonnie Lysyk recently examined that model.

She concluded Infrastructure Ontario frequently gets its head handed to it in partnerships with the private sector, to the tune of billions of dollars in added costs.

Lysyk said the government could save money on infrastructure projects if it could competently manage them itself. (A big “if”.)

Finally, the CPPIB, which has a five-year annualized rate of return of 11.9% and a 10-year rate of 7.1%, invests only 6.1% of its portfolio in infrastructure (including a stake in the Hwy. 407 ETR).

Based on the little the Wynne government has said about how it will operate the ORPP, we should all be concerned.
The Toronto Sun as been quite critical of Premier Wynne’s pension mystery:
Premier Kathleen Wynne’s Ontario Retirement Pension Plan (ORPP) will have a huge impact on the pocketbooks of millions of workers.

But with the plan set to start Jan. 1, 2017, the Liberals have provided little information about it.

Among the key unanswered questions:

Who will be included?

How will the Liberals invest the $3.5 billion-a-year it will generate?

Wynne has said except for the self-employed, if you work for a business that does not provide a private pension plan, you have to join the ORPP.

You will pay 1.9% of your annual salary into the ORPP through a payroll tax, with your employer matching your contribution.

To give an idea of the costs, if you make $45,000 annually starting at age 25 and contribute for 40 years, you will make annual payments of $788, matched by your employer. At age 65 you will receive a pension until you die of $6,410 annually, in 2014 dollars.

If you earn $90,000 annually (earnings above this are exempt), you will pay $1,643 annually and receive a pension of $12,815.

But what is Wynne’s definition of a private pension plan?

Originally it was thought to mean any private workplace pension.

But pension experts now say it’s unclear whether workers in defined contribution plans will be exempt from the ORPP.

In these plans, the employer and employee make annual contributions, but there is no guarantee of what the final pension will be.

By contrast, defined benefit plans pay a pre-determined pension based on salaries and years of experience.

(We do know workers with defined benefit plans will be exempt from the ORPP.)

But it’s also unclear how the province will invest the $3.5 billion annually in new revenue the ORPP will generate, important so that it remains solvent and able to meet its financial obligations.

Wynne’s Liberals have sent out contradictory messages on this.

They have said both that the ORPP will be managed by an independent investment board like the Canada Pension Plan, but also that it will invest in Ontario government public-private infrastructure projects, meaning the board won’t be truly independent.

Ontarians have a right to answers. After all, it’s their money at stake.​
No doubt, Ontarians have a right to know more details of this new pension plan, but I think the media is getting ahead of themselves here. There have been quite a few dumb attacks on the ORPP, all backed by Canada's powerful financial services industry.

Having said this, I like Lorrie Goldstein's comment above because he's right, when politicians get involved in public pensions, it's a recipe for disaster. Infrastructure Ontario is proof of how billions in public finances are squandered on projects with little or no accountability.

The first thing this Liberal government needs to do is create a legislative act which clearly outlines the governance of this new pension plan. This sounds a lot easier than it actually is. Not long after I was wrongfully dismissed at PSP in October 2006, I was approached by the Treasury Board of Canada to conduct an in-depth report on the governance of the public service pension plan. I wrote about it in my comment on the Auditor General slamming public pensions:
I wrote my report on the governance of the federal government's public sector pension plan for the Treasury Board back in the summer of 2007. The government hired me soon after PSP Investments wrongfully dismissed me after I warned their senior managers of the 2008 crisis. And I didn't mince my words. There were and there remains serious issues on the governance of the federal public sector pension plan.

I remember that summer very well. It was a very stressful time. PSP was sending me legal letters by bailiff early in the morning to bully and intimidate me. I replied through my lawyer and just hunkered down and finished my report. The pension policy group at the Treasury Board didn't like my report because it made them look like a bunch of incompetent bureaucrats, which they were, and they took an inordinate amount of time to pay me my $25,000 for that report (the standard amount when you want to rush a contract through and not hold a bidding process).

If I had to do it all over again, I wouldn't have written that report. The Treasury Board buried it, and it wasn't until last summer that the Office of the Auditor General finally started looking into the governance of the federal public sector pension plan.

In 2011, the Auditor General of Canada did perform a Special Examination of PSP Investments, but that report had more holes in it than Swiss cheese. It was basically a fluff report done with PSP's auditor, Deloitte, and it didn't delve deeply into operational and investment risks. It also didn't examine PSP's serious losses in FY 2009 or look into their extremely risky investments like selling CDS and buying ABCP, something Diane Urqhart analyzed in detail on my blog back in July 2008.

I had discussions with Clyde MacLellan, now the assistant Auditor General, and he admitted that the Special Examination of PSP in 2011 was not a comprehensive performance, investment and operational audit. The sad reality is the Office of the Auditor General lacks the resources to do a comprehensive special examination. They hire mostly CAs who don't have a clue of what's going on at pension funds and they need money to hire outside specialists like Edward Siedle's Benchmark Financial Services.
Pension governance is my forte, which is why Canada's pension plutocrats get their panties tied in a knot every time I expose some of them for being grossly overpaid public pension fund managers.

But compensation is just one component of good pension governance. If you listen to some CEOs at Canada's coveted public pensions, you'd think it's the most important factor in determining their success but I beg to differ. It's one of many factors that has contributed to the long-term success at Canada's large public pensions.

Clearly, the most important thing is to separate the operations of a pension fund from government bureaucrats looking to interfere in decisions in their hopeless attempt to influence key investment decisions and indirectly buy votes. Public pensions funds need to be governed by qualified, independent board of directors.

I've worked in the private sector (BCA Research, National Bank), at Crown corporations (Caisse, PSP Investments, BDC) and the public sector (Canada Revenue Agency, Treasury Board, Industry Canada), and I can tell you what works and what doesn't at all these places. The last thing I want to see is government bureaucrats interfering with the operations of public pensions, especially ones like the ORPP or CPPIB.

Wynne's government has taken bold steps to bypass the federal government, which is still pandering to banks and insurance companies, to introduce its version of an enhanced CPP for Ontario's citizens which need better retirement security. If the feds did the right thing and enhanced the CPP for all Canadians, we wouldn't be talking about the Ontario Retirement Pension Plan (ORPP).

But now that the horse is out of the barn, Ontarians have a right to know a lot more. As always, the devil is in the details. I know there are eminently qualified people consulting the Liberals on this new pension plan, people like Jim Keohane, HOOPP's CEO and someone who believes in this new plan.

Of course, I wasn't invited to share my thoughts and for good reason. I've seen the good, bad and ugly working at and covering Canada's pensions and would recommend world class governance rules that would make Canada's pension plutocrats very nervous.

In the Leo Kolivakis world of pension governance, there would be no nonsense whatsoever. I would change the laws to make sure all our public pension funds have to pass a rigorous and comprehensive performance, risk and operational audit by a fully independent and qualified third party group that specializes in pension proctology (and it's not just Ted Siedle). These audits would occur every three years and the findings would be disclosed to the public via the auditor generals (they can oversee such audits).

What amazes me is how everyone touts how great Canada's pension governance is when in reality I can point to some serious lapses in the governance at all our coveted public pension plans. For example, none of our "world class" public pensions disclose board minutes (with an appropriate lag) or even televise these minutes. When it comes to communication, some are a lot better than others but they still need to improve and have embeddable videos of speeches and more explaining how they invest (Ontario Teachers and HOOPP does a decent job there; communication at PSP is non-existent).

What else? Diversity, diversity, diversity! I'm tired of seeing good old white boys (and a token white lady) when I look at the senior managers of the Canada Pension Plan Investment Board or other large Canadian public pensions. Don't get me wrong, I'm sure they're highly qualified professionals but the sad reality is this image doesn't represent Canada's rich cultural diversity and it sends the wrong message to our ethnic and other minorities.

When I wrote my comment on the importance of diversity at the workplace, I recommended that each of our public pension funds include a diversity section in their annual report discussing what steps they're taking to diversify their workforce and include hard numbers on the hiring of women, visible minorities, aboriginals and people with disabilities.

This is one area where I think we need more, not less, government intervention because I simply don't trust the "independent" board of directors overseeing these funds and think they're all doing a lousy job on diversity at the workplace just like they're doing a lousy job getting the benchmarks of their private market investments right, which is why you're seeing compensation soar to unprecedented levels at some of Canada's large public pensions (I believe in paying for performance that truly reflects the risks an investment manager is taking).

As you can see, I don't mince my words and I certainly don't suck up to any of Canada's "powerful" pension titans. They're perfectly content blacklisting me from being gainfully employed at their organizations because of my blog and more truthfully, because I have progressive multiple sclerosis (even though it's illegal to discriminate and I'm perfectly capable of working as long as they accommodate me which they are required to do by law), and I'm content writing my comments exposing all the nonsense I see at their pensions.

The irony is if any of these powerful pension titans had any brains whatsoever, they'd be working feverishly hard to hire me or find me a good job so I can stop writing my blog exposing uncomfortable truths. Instead, they keep discriminating against me, providing the lamest excuses and quite frankly, violating my right to apply to jobs I'm eminently qualified for (unfortunately and hardly surprisingly, Mr. Bourbonnais is no different from his predecessor and it remains to be seen if he'll change PSP's culture for the better. So far, I see more of the same, except he will surround himself with his own French Canadian people).

On that note, I'm off to the gym to enjoy my day. I don't get paid enough for writing these lengthy, hard-hitting comments and I'm going to spend a lot more time analyzing these schizoid markets and trading stocks and less time on Canada's pensions which keep disappointing me on so many levels.

You can dismiss some or all of my comments as coming from a 'disgruntled former employee' but the truth is if any of you had to put up with a fraction of what I have put up with, you'd be curled up in a fetal position, completely depressed from life. I'm actually quite happy with my life and choose to fight on even when the odds are stacked against me.

My last word of advice to Premier Wynne is to fight the feds and all negative press and forge ahead with the Ontario Retirement Pension Plan (ORPP). Good pension policy makes for good economic policy. If you want to put an Ontario spin to this plan, follow the example of the Caisse which has a dual mandate in Quebec and is going to handle some of Quebec's infrastructure projects.

But whatever you do with the ORPP, make sure you get the governance right, following examples at CPPIB and elsewhere, and set the bar extremely high when it comes to governance. I've only provided a few examples on how governance can be improved at all of Canada's large public pensions, there are plenty more. The ORPP is in a beautiful position to learn from others, incorporating some of their governance and improving on it where it falls short (if you want my advice, you need to pay me big bucks to consult you because I learned from my past mistakes consulting the feds).

Below, Cristina Martins’ debate statement in the Legislature regarding the Ontario Retirement Pension Plan (Feb. 19, 2014). You know my thoughts, I'm all for the ORPP but the devil is in the details. If they bungle up the governance of this plan, it's doomed to fail, but if they get it right, it will flourish and bolster the retirement security of millions of Ontario workers who desperately need something better to retire in dignity and security.

And if you haven't seen it, watch Noah Galloway dance with Sharna on Dancing With the Stars. It is very inspirational and shows you the best way to fight discrimination is to focus on people's abilities, not their disabilities!!


Tuesday, May 19, 2015

Is The Greek Endgame Near?

Holly Ellyatt of CNBC reports, Greece 'in crisis' as officials insist deal is near:
Greek government officials are insisting that a deal with the country's international lenders over reforms is imminent, but one key business leader told CNBC that Greece needs to implement reforms fast, whether a deal is on the cards or not.

"Greece is in a liquidity trap. We need to rectify the situation and agree on certain issues," Costantine Michalos, president of the Union of Hellenic Chambers of Commerce & Industry, told CNBC Tuesday.

"You don't need an agreement with your lenders and partners to improve your tax collecting mechanism, you don't need an agreement to improve your labor laws based on European norms on flexibility, and you don't need an agreement in order to proceed with privatizations," he added.

It comes as Greece's Labour Minister, Panos Skourletis, added his voice to that of the prime minister and finance minister, insisting that a deal with creditors was imminent "in the coming days," Reuters reported Tuesday.

Greece has been negotiating with creditors for months over reforms that -- when implemented -- could unlock a last tranche of much-needed bailout aid, worth 7.2 billion euros ($8.14 billion).

Sticking points in the talks have ranged from labor market and pension reforms to disputes over the privatization of Greek state assets, although Greece has made some concessions on the latter point.

Greek Prime Minister, Alexis Tsipras, on Monday ruled out further pension cuts, but said a list of proposals for an overhaul of the nation's VAT (sales tax) regime had been sent to lenders and he claimed a deal was imminent.

Speaking at a meeting of the Greek Industrial Federation Monday, Tsipras said Greece had tabled proposals for a "viable deal with creditors" and that the country was "in the final straight for an agreement."

The remarks were echoed by the country's Finance Minister, Yanis Varoufakis, who added that Greece was near a cash-for-reforms deal with its euro zone partners and the International Monetary Fund (IMF) that would help it meet debt repayments next month.

"I think we are very close (to a deal) ... let's say in a week," Varoufakis told Greek TV channel, Star TV. "Another currency is not on our radar, not in our thoughts."

He also suggested that Europe's bailout fund pay back the country's maturing bonds held by the European Central Bank (ECB), and that Greece could pay it back at a later date.

There are also growing concerns that Greece could be facing bankruptcy, amid a risk of a default on debts to international creditors, with deadlines looming for repayments to the ECB and IMF next month.
Nikos Chrysoloras and Vassilis Karamanis of Bloomberg also report, Greek Endgame Nears for Tsipras as Collateral Evaporates:
Greek banks are running short on the collateral they need to stay alive, a crisis that could help force Prime Minister Alexis Tsipras’s hand after weeks of brinkmanship with creditors.

As deposits flee the financial system, lenders use collateral parked at the Greek central bank to tap more and more emergency liquidity every week. In a worst-case scenario, that lifeline will be maxed out within three weeks, pushing banks toward insolvency, some economists say.

“The point where collateral is exhausted is likely to be near,” JPMorgan Chase Bank analysts Malcolm Barr and David Mackie wrote in a note to clients May 15. “Pressures on central government cash flow, pressures on the banking system, and the political timetable are all converging on late May-early June.”

European policy makers are losing patience with Tsipras who said as recently as May 14 that he won’t compromise on any of his key demands. He’s planning to force a discussion of Greece at a summit of European Union leaders in Latvia that begins on May 21, a day after the European Central Bank’s Governing Council meets in Frankfurt.
Bonds Drop

Greek bonds tumbled on Monday, pushing 10-year yields up by the most since January. Yields on two-year Greek notes jumped 352 basis points to 24.44 percent. Greek bonds remain the best-performing sovereign securities over the past month, according to Bloomberg’s World Bond Indexes. The Athens Stock Exchange rose 1.6 percent, following a report that the European Commission is trying to broker a compromise deal. An EU Commission spokeswoman said she wasn’t aware of such a proposal.

While talks are centering on whether to give Greece more money, the ECB could decide to raise the stakes as soon as this week if it increases the discount on the collateral Greek banks pledge in exchange for cash under its Emergency Liquidity Assistance program.

Such a move might inadvertently prompt a further outflow of bank deposits and pressure Tsipras to choose between doing a deal and putting his country on the road to capital controls. A Greek government spokesman declined to comment, as did officials at the Greek central bank and the ECB.

“We are in an endgame,” ECB Executive Board member Yves Mersch said in an interview with Luxembourg radio 100.7 broadcast Saturday. “This situation is not tenable.”
Liquidity Lifeline

The arithmetic goes as follows: Greek lenders have so far needed about 80 billion euros ($91 billion) under the ELA program.

Banks have enough collateral to stretch that lifeline to about 95 billion euros under the terms currently allowed by the ECB, a person familiar with the matter said. With the central bank raising the ELA by about 2 billion euros every week, that could take banks to the end of June.

A crunch will come if the ECB increases the haircut on Greek collateral to levels not seen since last year. That could be prompted by anything from a complete breakdown in talks to a missed debt payment, the official said. A continuation of the current impasse could even be all that’s needed, the official said.

An increased haircut would reduce the ELA limit to about 88 billion euros, the person said. While that gives banks about four weeks before hitting the buffers, the leeway is so limited that Greece might need to impose capital controls, limiting transactions such as ATM withdrawals, to conserve the cushion. Market News International first reported on the reduced ceiling on May 12.
ECB Tools

“Since the great crisis of 2008, Europe has created many tools to control the flow of money and banks,” said Andreas Koutras, an analyst at In Touch Capital Markets in London. “Thus the crisis in Greece is more likely to be resolved through the tools of the ECB rather than” by political means.

Investors in Greek debt are showing few signs of panic for now, with the yield on the Greek 10-year bond still having dropped about 2.2 percentage points lower than its two-year high of 13.64 percent on April 21.

Nor are ECB policy makers willing to raise the pressure on Greek banks on their own. Central bank governors won’t take any action which would be seen as pushing Greece out of the currency bloc if negotiations show progress and convergence, the person said.

Collateral Fix?

Greek lenders are also working with the country’s central bank on plans to collateralize additional assets, a separate local official with knowledge of the matter said.

Still, it’s unclear if these assets, including government guarantees, would be accepted by the ECB if the standoff in bailout negotiations persists. According to a senior Greek commercial banker, the ECB’s decision on what to accept as collateral is essentially a judgment call, and not necessarily related to the quantity of the assets available.

“The Greek government at this point has no room for maneuver,” Spanish Economy Minister Luis de Guindos said in a speech in Madrid on Monday. He said he was still optimistic a deal will be reached in the coming days. “This deal is essential for Greece given its liquidity situation,” he said.

Tsipras will push Greece’s case at this week’s EU leaders’ summit in Riga after a weekend that showed few signs of progress. An International Monetary Fund memo dated May 14 said Greece won’t be able to make an IMF payment on June 5 unless an accord is reached with partners, the U.K’s Channel 4 news reported on Saturday.

The ECB’s next full monetary policy meeting is on June 3, two days before the IMF payment.

“There were too many people crying wolf before,” Koutras said. “But as Hemingway wrote: How did you go bankrupt? Two ways: Gradually, then suddenly.”
It's clear that the Greek endgame is near. We're fast approaching another major crunch and Anatole Kaletsky thinks Syriza will blink:
Once again, Greece seems to have slipped the financial noose. By drawing on its holdings in an International Monetary Fund reserve account, it was able to repay €750 million ($851 million) – ironically to the IMF itself – just as the payment was falling due.

This brinkmanship is no accident. Since coming to power in January, the Greek government, led by Prime Minister Alexis Tsipras’s Syriza party, has believed that the threat of default – and thus of a financial crisis that might break up the euro – provides negotiating leverage to offset Greece’s lack of economic and political power. Months later, Tsipras and his finance minister, Yanis Varoufakis, an academic expert in game theory, still seem committed to this view, despite the lack of any evidence to support it.

But their calculation is based on a false premise. Tsipras and Varoufakis assume that a default would force Europe to choose between just two alternatives: expel Greece from the eurozone or offer it unconditional debt relief. But the European authorities have a third option in the event of a Greek default. Instead of forcing a “Grexit,” the EU could trap Greece inside the eurozone and starve it of money, then simply sit back and watch the Tsipras government’s domestic political support collapse.

Such a siege strategy – waiting for Greece to run out of the money it needs to maintain the normal functions of government – now looks like the EU’s most promising technique to break Greek resistance. It is likely to work because the Greek government finds it increasingly difficult to scrape together enough money to pay wages and pensions at the end of each month.

To do so, Varoufakis has been resorting to increasingly desperate measures, such as seizing the cash in municipal and hospital bank accounts. The implication is that tax collections have been so badly hit by the economic chaos since January’s election that government revenues are no longer sufficient to cover day-to-day costs. If this is true – nobody can say for sure because of the unreliability of Greek financial statistics (another of the EU authorities’ complaints) – the Greek government’s negotiating strategy is doomed.

The Tsipras-Varoufakis strategy assumed that Greece could credibly threaten to default, because the government, if forced to follow through, would still have more than enough money to pay for wages, pensions, and public services. That was a reasonable assumption back in January. The government had budgeted for a large primary surplus (which excludes interest payments), which was projected at 4% of GDP.

If Greece had defaulted in January, this primary surplus could (in theory) have been redirected from interest payments to finance the higher wages, pensions, and public spending that Syriza had promised in its election campaign. Given this possibility, Varoufakis may have believed that he was making other EU finance ministers a generous offer by proposing to cut the primary surplus from 4% to 1% of GDP, rather than all the way to zero. If the EU refused, his implied threat was simply to stop paying interest and make the entire primary surplus available for extra public spending.

But what if the primary surplus – the Greek government’s trump card in its confrontational negotiating strategy – has now disappeared? In that case, the threat of default is no longer credible. With the primary surplus gone, a default would no longer permit Tsipras to fulfill Syriza’s campaign promises; on the contrary, it would imply even bigger cutbacks in wages, pensions, and public spending than the “troika” – the European Commission, the European Central Bank, and the IMF – is now demanding.

For the EU authorities, by contrast, a Greek default would now be much less problematic than previously assumed. They no longer need to deter a default by threatening Greece with expulsion from the euro. Instead, the EU can now rely on the Greek government itself to punish its people by failing to pay wages and pensions and honor bank guarantees.

Tsipras and Varoufakis should have seen this coming, because the same thing happened two years ago, when Cyprus, in the throes of a banking crisis, attempted to defy the EU. The Cyprus experience suggests that, with the credibility of the government’s default threat in tatters, the EU is likely to force Greece to stay in the euro and put it through an American-style municipal bankruptcy, like that of Detroit.

The legal and political mechanisms for treating Greece like a municipal bankruptcy are clear. The European treaties state unequivocally that euro membership is irreversible unless a country decides to exit not just from the single currency but from the entire EU. That is also the political message that EU governments want to instill in their own citizens and financial investors.

If Greece defaults, the EU will be legally justified and politically motivated to insist that the euro remains its only legal tender. Even if the Greek government decides to pay wages and pensions by printing its own IOUs or “new drachmas,” the European Court of Justice will rule that all domestic debts and bank deposits must be repaid in euros. That, in turn, will force a default against Greek citizens, as well as foreign creditors, because the government will be unable to honor the euro value of insured deposits in Greek banks.

So a Greek default within the euro, far from allowing Syriza to honor its election promises, would inflict even greater austerity on Greek voters than they endured under the troika program. At that point, the government’s collapse would become inevitable. Instead of Greece exiting the eurozone, Syriza would exit the Greek government. As soon as Tsipras realizes that the rules of the game between Greece and Europe have changed, his capitulation will be just a matter of time.
Andreas Koutras shared this with me: "Can someone say to Anatole that lack rationality and logic is exactly why Greece is in the current position. He is applying the wrong tool for the situation. Many have made this mistake including myself."

I'm not going to get into the strengths and weaknesses of Kaletsky's arguments but he makes one valid point, Syriza will be much weaker if it decides to default and it will implode. Also, as I explained in my last comment on a new deal for Greece,  Grexit and return to the drachma will bring about much more pain and devastation to Greece than the mindless austerity troika imposed on the country.

Interestingly, the Globe and Mail reports on a mysterious spike in the shares of a small Canadian pulp and paper stock is rumored to foretell an exit of Greece from the eurozone.

I strongly doubt that Grexit is going to happen, at least not this summer. With Greek tourism season set to commence, it's not in anyone's best interest to have a crisis now. But the endgame is near and I think Syriza will blink and disenchanted Greeks will realize there is no easy solution to the country's economic woes.

Below, a Bloomberg discussion on whether Greece’s endgame includes a referendum. And Costantine Michalos, president of the Union of Hellenic Chambers of Commerce & Industry, tells CNBC that "Greece is in a liquidity trap and we need to rectify the situation and agree on certain issues."

Friday, May 15, 2015

Are U.S. Pension Funds Delusional?

John Coumarianos of Institutional Imperative wrote a comment for MarketWatch, You could be on the hook for pension funds’ lofty stock-market views:
What do Connecticut teachers and Dallas policemen and firemen have in common? They’re public sector employees whose respective pension funds are projecting 8.5% annualized long-term investment returns.

Along with the Houston Firefighters Fund and the Milwaukee City Employees Retirement System, which also project 8.5% returns, the Connecticut Teachers Pension Fund and the Dallas Policemen and Firemen Fund have the highest assumed rate of return of any public employee pension fund in the Boston College Center for Retirement Research’s database.

Relative to their peers, none of these four pension funds have outlandish assumptions. All 150 public employee pension funds in CRR’s database have an average estimated investment return of 7.7%. Twenty funds are at the median (half the funds are higher and half are lower) assumption of 7.8% returns. Forty funds share the mode (most occurring assumption) of 7.5%.

Nearly 97% of the funds posts return assumptions in the 7%-8% range after rounding. This is an extremely tight data set with regard to return assumptions, which should make anyone wonder why there are almost no differences of opinion.

The lowest assumed rate of investment return (and the only one that clocks in under 6%) is the Pennsylvania Municipal Retirement System’s at 5.5% (click on image).


Unfortunately, relative to some respected investors’ estimates of what mainstream stocks and bonds are likely to deliver over the next seven-to-10 years, every fund in CRR’s database except the Pennsylvania Municipal Retirement System may be projecting unrealistically high returns.

Likely future stock and bond returns

The easiest way to question these 7%-8% pension fund investment return assumptions is to begin with bonds. The 10-year Treasury is currently yielding a bit over 2%. That means an investor holding the instrument to maturity will get the yield it delivers, nothing more and nothing less. Perhaps investment grade corporate bond holders will receive 3%.

While junk bonds are yielding in the 5%-6% range, that’s not much given the asset class’s historical average default rate. Because defaults have pronounced cycles — moments where they seldom occur and moments when they’re rampant — it’s likely investors have fooled themselves that the current low-default environment is permanent.

Many investors think emerging markets bonds will deliver a bit more — say, 2.5% after inflation, or 5% assuming a 2.5% rate of inflation.

So altogether, let’s say the bond part of a pension fund’s portfolio will return 3.5% for the next seven-to-10 years (not counting management fees).

If our bond return assumption is correct, the stock part of a balanced portfolio split roughly evenly between stocks and bonds will have to deliver more than 10% annualized for the entire portfolio to approach a 7% return. Stocks will have to deliver close to 13.5% to the Connecticut teachers or the Dallas policemen and firemen to sustain those public employees through retirement.

Can stocks rise to these feats of heroism over the next decade or so? Not likely, according to Boston-based asset manager Grantham, Mayo, van Oterloo (GMO).

GMO, which lists its asset-class return assumptions monthly, currently thinks most developed market stocks will produce negative real — or after-inflation — returns over the next seven years. The firm evaluates stocks on long-term metrics such as (but not exclusively) current price over past 10-years’ inflation-adjusted average earnings, also known as the “Shiller P/E” after Yale economics professor Robert Shiller. Based on past earnings, GMO says, stocks are expensive and therefore poised for low future returns (click on image).

Since GMO publishes real or inflation-adjusted return numbers, one can just add an inflation assumption (say, 2%-3%) to the return forecast to get a nominal number, which is what the pension funds use. For example, GMO’s expected negative 2.0% real return for U.S. large company stocks might be a 1% nominal return if you assume 3% inflation. That’s breathtakingly far away from what the pension funds are assuming.

In developed markets only the highest-quality domestic stocks — those that consistently produce returns on invested capital in excess of their cost of capital and may be said to have economic “moats” or durable competitive advantages — are priced to deliver a minuscule 0.5% annualized real return, according to GMO.

Emerging markets stocks are the best of the bunch at 2.7% annualized for the next seven years. If one assumes 2.5% inflation, that’s a 5.2% nominal return — still far from (likely only about half) what they need to deliver to satisfy pension funds’ total portfolio return assumptions.

Although the starting yield does well in predicting future bond returns, predicting future stock future returns is fraught with difficulty.

Nevertheless, the pension funds have already made assumptions about future returns, as they must, and it’s not clear they’ve put much thought into the exercise. While century-long returns of a balanced portfolio may be in the 7% range, such portfolios go through multi-decade periods without returning anything close to the century-long results.

The pension funds have evidently made no attempt to take a measure of current valuation to arrive at their assumptions. They seem to have lazily plugged in century-long returns to satisfy their assumption requirements.

As for the Shiller P/E and GMO’s work, they are based on past earnings rather than being a complete guess as to what might materialize in the future. GMO has good, if imperfect, records in forecasting future seven-to-10 year stock returns, as this academic paper indicates.

Revising return assumptions downward would undoubtedly cause pension funds pain. Failing to do so, however, will cause future pensioners and possibly taxpayers pain. Public sector pension funds need to go back to the drawing board — or need to be made to go back to the drawing board — to think about future returns.
This is another excellent comment discussing the pension rate-of-return fantasy. Unfortunately, NASRA is still smoking hopium and nobody wants to talk about the elephant in the room. I fear the worst for pensions as global deflation sets in, decimating them and forcing them to come to grips with the fact that 8% will turn out to be more like 0% or lower in coming decade(s).

Nonetheless, the talking heads on Wall Street are talking up global reflation and U.S. public pension funds are increasingly shifting assets into high fee private equity, real estate and hedge funds to make that 8% bogey. Unfortunately for them, they will fall well short of their target, but they will succeed in enriching a bunch of overpaid hedge fund and alternatives managers that are preparing for war.

In my humble opinion, U.S. public pensions should heed the wise advice of the Oracle of Omaha as well as that of the king of hedge funds and steer clear of this space (because most don't have a clue of what they're doing).

They should also pay close attention to Ron Mock, the President and CEO of the Ontario Teachers' Pension Plan, who recently sounded the alarm on alternatives. It's worth noting that unlike U.S. public pension funds, the Oracle of Ontario uses one of the lowest discount rates in the world to discount their future liabilities and they monitor all risks very closely as they try to match assets with liabilities.

In fact, Neil Petroff, the soon to be retired CIO of Ontario Teachers once told me flat out: "If U.S. public pension funds used our discount rate, they'd be insolvent."

And the reality is that a lot of U.S. public pension funds are insolvent and their fate lies in the hands of judges and taxpayers. Steve Moore at Forbes reports, Judges For Higher Taxes, Not Pension Reform, In Illinois:
Last week the Illinois Supreme Court overturned a state law that would help fix the state’s notorious pension crisis. What a tragedy for the state’s taxpayers. The justices basically ruled that the pension arrangements are iron-clad, although these pensions are on a course to bankrupt the state and imperil public services that Illinois families depend on. The unions come first. This could have negative consequences for more than half the states that are trying to defuse government employee pension time bombs. ‎

By way of background: Illinois has one of the deepest public employee pension holes in the nation. The long term deficit is estimated at above $110 billion and the red ink rises every year. Even in California – where several cities have declared bankruptcy – the pension sink hole isn’t as deep on a per capita basis.

The watchdog group Open the Books reports that there are more than 5,000 teacher and other education officials who receive an annual pension of more than $100,000 a year. Worse yet, half of all government employees retire with benefits before age 60. That’s more than twice what a typical private worker gets for having worked 12 months, not nine months, a year.

The Illinois court invalidated a 2013 pension fix that was enacted by a Democratic legislature and a Democratic governor, Pat Quinn. That law cut off the front door to the pension swindle – switching new workers into defined contribution programs like 401k plans. The law also adjusted the automatic cost of living adjustments (now at 3 percent annually regardless of inflation). The reform also adjusted the retirement age for new employees after January 2011, highly important because at least half of the employees covered are retiring before age 60—including 70 percent of teachers. Even the features of the law dealing with new employees entering the bankrupt system were unbelievably tossed out by the court meaning that the costs must keep rising inexorably into virtual perpetuity.

The victims of these daunting pension costs are citizens who rely on state services. Pension checks are crowding out funding for everything else and last year rose 12 percent as most state spending is being cut or frozen.

Thanks to this ruling, there is no way out of the pension calamity absent a repeal of the pension clause in the Illinois Constitution.

The state can’t borrow – it already has the worst credit rating in the nation. It has to borrow less – not more. Last week’s court decision sent interest rates on Land of Lincoln debt to even higher levels – near junk bond status. Days later, Chicago bonds were marked down to junk status.

The state is already making deep cuts in other spending programs. To accommodate lavish government retiree pensions, the court has rules that everything else – from funding for schools, roads, bridges, prisons, and ‎police services – gets whacked. Current Governor Bruce Rauner is taking on the unenviable job of cutting at least $6 billion from state spending in order to balance the budget. The Court just made his job doubly excruciating.

The liberal justices made no secret of their preferred fix: raise taxes. ‎They wrote: “the General Assembly could have also sought additional tax revenue,” and they chastised lawmakers for allowing a highly unpopular temporary tax increase to expire “even as pension funding was being debated and litigated.” But that tax hike was never meant to pay for pensioners even though most of the money was used to plug the massive growth in annual retirement payments. ‎

Raising taxes is an economic suicide pact for Illinois citizens. Illinois is already losing businesses and jobs due to some of the highest tax burdens in America. Raising taxes, as the pols in Springfield found out in recent years, raises almost no money because it accelerates the exodus to Texas, Florida, and Arizona.

The Court rejected the plea by lawmakers and others that the pension crisis qualifies as an emergency that grants the legislature the option of disregarding the pension protection clause. But this problem is a financial ticking time bomb that imperils funding for basic services that taxpayers and businesses depend on. ‎Is it not an emergency if the municipalities can’t get ambulances or fire trucks to their residents for lack of funds?

As in so many states today, pension costs in Springfield are crowding out funding for basic municipal services taxpayers depend on. The cost of borrowing keeps rising because of investor fear that these states will soon look like Greece. Balancing the budget now seems impossible. And the only people feeling financially secure are the state’s retired government employees – many of whom have moved to Palm Beach and Phoenix.

If courts won’t allow states to trim pension costs, eventually states like Illinois will rush to Washington for federal bailout money. With more than $1 trillion in unfunded public pensions nat‎ionwide, Illinois is looking like the canary in the coal mine. What a tragedy if courts in other states prevent legislatures from defusing these fiscal time bombs.
It's funny how the media is focused on dwindling pensions in Greece when the reality is that Illinois, Kentucky and other states are the next Greece. I started writing about pension bombs exploding everywhere back in 2008. Nobody was taking me seriously back then but they're reading me now and scared to death of what's going to happen with their pension.

While the Forbes article above raises excellent points, I don't particularly like it because it ignorantly promotes 401(k)s as the ultimate pension fix. This is pure rubbish. The 401(k) experiment has been an abysmal failure in the United States of Pension Poverty and the brutal truth is that defined-contribution plans don't mitigate against pension poverty, they exacerbate it.

As I stated in my last comment on Social Security, the only real long-term solution to the retirement crisis gripping the United States is to follow the model of the Canada Pension Plan whose assets are managed by the CPPIB. Of course, to do this properly, U.S. policymakers need to get the governance right and have the assets managed at arms-length from any government. And the big problem with U.S. public pensions is they're incapable of getting the governance right.

Why am I such a stickler on enhancing the CPP for all Canadians and enhancing Social Security for all Americans? Very simple. I believe the world is heading down a very uncertain path and in this environment, I want to see people's pensions managed by professional pension fund managers who can lower costs and invest across public and private market assets and anything in between.

The added advantage of enhancing the CPP or Social Security is people can pretty much work across the public and private sector and their pensions would be safely managed by professional pension fund managers (no issue of pension portability). Companies which are already dropping defined-benefit pensions wouldn't need to worry about pensions, they would just contribute to their employees' pensions.

It's also worth mentioning once again that good pension policy is good economic policy. The benefits of defined-benefit plans are not well understood or appreciated but when people retire knowing they have fixed payments till they die, they're able to spend more and governments are able to collect more taxes. In the long-run, enhancing defined-benefit plans isn't going to increase debt. If done right by introducing risk sharing, it will lower debt and help mitigate against downturns in the economy.

As far as young teachers, police officers, firemen, and other public sector workers working in the U.S., I'll give you the same advice that I give my girlfriend who is a young teacher here in Quebec. Even if you have what seems as a safe pension, don't take it for granted and save whatever you can, investing in dividend ETFs because you simply don't know what the future holds.

I personally learned that lesson the hard way. First in June 1997 when I was diagnosed with multiple sclerosis (MS) and second in October 2006 when I was wrongfully dismissed at PSP after warning Gordon Fyfe and their senior managers of the credit crisis. I know all about life and death on Wall Street and what it means to struggle when the odds are against you.

But I also learned a much more important lesson in life, the value of perseverance, self-discipline and focusing on what really matters and the people that truly love me. Trust me, there are a lot funner things I can be doing with my time than spending a few hours a day writing a blog on pensions and investments but I take the issue of retirement security extremely seriously and have devoted a good chunk of my life on this topic trying to help promote a healthy and much needed discussion on reforming pensions for the better, not worse.

All I ask from my readers is that you take the time to click my ads and donate or subscribe to my blog on the top right-hand side. Institutions that can afford to give a lot more are kindly requested to subscribe using one of the three options. I thank all of you who have done so and ask others to follow suit.

Below, Manhattan Institute Senior Fellow Steve Malanga and Chicago radio talk show host Dan Proft on growing concerns over Illinois’ pension crisis. Illinois has yet to slay its pension dragon and is heading the way of Detroit and Greece. Unfortunately, so are many other state plans suffering from the delusions of lofty investment assumptions which simply won't materialize.

Thursday, May 14, 2015

Social Security On The Fritz?

Janet Novack of Forbes reports, Social Security In Far Worse Shape Than Official Numbers Show:
Over the last 15 years, the Social Security Administration’s Office of the Chief Actuary has consistently underestimated retirees’ life expectancy and made other errors that make the finances of the retirement system look significantly better than they are , a new study by two Harvard and one Dartmouth academics concludes. The report, being published today by the Journal of Economic Perspectives, is the first, the authors say, to compare the government agency’s past demographic and financial forecasts with actual results.

In a second paper appearing today in Political Analysis, the three researchers offer their theory of  why the Actuary Office’s predictions have apparently grown less reliable since 2000:  the civil servants who run it have responded to increased political polarization surrounding Social Security “by hunkering down” and resisting outside pressures—not only from the politicians, but also from outside technical experts. “While they’re insulating themselves from the politics, they also insulate themselves from the data and this big change in the world –people started living longer lives,’’ coauthor Gary King, a leading political scientist and director of Harvard’s Institute for Quantitative Social Science, said in an interview Thursday. “They need to take that into account and change the forecast as a result of that.”

In its annual report last July, Social Security predicted its old age and disability trust funds, combined, would be exhausted in 2033 and that after that point the government will have enough payroll tax revenues coming in to pay only about three quarters of promised benefits. King said his team hasn’t estimated how much sooner the fund might run out, but described it as in “significantly worse shape” than official forecasts indicate.

In addition to underestimating recent declines in mortality (i.e. increases in life expectancy) for those 65 and older, the Actuary has overestimated the birth rate—meaning the number of new workers who will be available to pay baby boomers their benefits 20 years from now , the researchers assert. Before 2000, the Actuary also made errors, but they went in both directions and the Actuary was readier to adjust the forecasts from year to year as new evidence came in, King said. Since 2000, he added, the errors “all are biased in the direction of making the system seem healthier than it really is.’’

A Social Security spokesman said today that Chief Actuary Stephen Goss couldn’t comment on the papers because he wasn’t provided them in advance and is tied up today in meetings with the Social Security Advisory Board Technical Panel.  But the spokesman pointed to an Actuarial Note which Goss and three colleagues published in 2013 in response to a New York Times op-ed by King and one of his current coauthors,  Samir Soneji, an assistant professor at Dartmouth’s Institute for Health Policy & Clinical Practice. In that op-ed, they attacked the Actuary’s methods of projecting mortality rates and predicted the trust fund would be depleted two years earlier than predicted. In their response, Goss and his colleagues called King and Soneji’s methods of predicting death rates “highly questionable” and noted that the Actuary’s methods have been audited since 2006 by an independent accounting firm and received unqualified opinions.

The dust-up might be ignored as bickering by the pointy heads, if it weren’t so consequential.  In a recent Gallup survey, 36% of workers said they were counting on Social Security as a major source of retirement income. Differences over the estimates are important, King observed, because they affect “basically half of the spending of the U.S. government,’’ including Medicare.  Moreover, the forecasting assumptions affect the projected impact of any proposed changes to the program.

In their political paper, King, Soneji and Konstantin Kashin, a PhD candidate at King’s institute, recount how partisan fighting over Social Security intensified in the late 1990s, when conservatives began arguing the program was unsustainable and should be partially privatized, with younger workers offered individual savings accounts. In 2001, newly elected President George W. Bush appointed a commission intended to support such a change, but he put the issue aside after the September 11 terrorist attacks. After his reelection in 2005, however, Bush started pushing for changes in a series of town halls and speeches that, the paper notes, put the Social Security actuaries under “an extreme form of political pressure.’’ Democrats and news reports pointed to changes in the language used by the Social Security Administration that seemed (in line with White House policy) to emphasize that the program was not financially sustainable. Goss openly clashed with a Republican Social Security Commissioner.

Bush’s privatization push flopped and during recent elections some Republicans have attempted to cast themselves as the protectors of Social Security, which enjoys strong support from voters across the political spectrum. In 2013, after President Obama proposed a deficit reduction deal that, along with raising taxes on the rich, would have chipped away at inflation adjustments in Social Security, the idea was attacked by politicians from both parties.

But the problem of how to solve the system’s long term funding deficit has hardly gone away and the political  heat seems to be rising again. Democrats have slammed a provision adopted by the new Republican Congress that would block a transfer of money from the Social Security old age fund to the Social Security disability fund, which will be depleted next year. They say such transfers have been routine in the past and that it is a ploy by Republicans to force cuts in the retirement program too. Last month, Republican New Jersey Gov. Chris Christie, a possible Presidential candidate, proposed that the age for receiving full Social Security benefits be raised gradually to 69 and that benefits be limited for individuals with more than $80,000 in other income and ended completely for those earning more than $200,000. 
King emphasized that there is “no evidence whatsoever,” that Goss and his actuaries are bending to political pressure from either Democrats or Republicans. On the contrary, he said, while resisting such pressure, they’ve put too high a value on remaining consistent in their forecasts, in part because they don’t want to “panic” the public. “They’re trying to show the numbers don’t change because they think it will inspire confidence. Maybe in the very short run it will inspire confidence by not changing the numbers. But having the numbers be wrong doesn’t inspire confidence at all,’’ King said.

The political paper asserts that Goss has resisted changes in forecasting assumptions suggested by the Social Security Advisory Board’s Technical Panel on Assumptions and Methods—a panel of actuaries and economists that meets once every four years and is in session now. In some cases, the paper claims, the Actuary has made some suggested change in an assumption, but then changed another, unrelated assumption in the opposite direction “to counterbalance the first and keep the ultimate solvency forecasts largely unchanged.” In their 2013 Actuarial Note, however, Goss and his colleagues say that while the 2011 Panel did push for faster changes in mortality assumptions, the panel’s recommendations, if adopted in full, would have actually resulted in a projection that the Social Security trust funds would run out a year later.

King, who presented his own findings to the Technical Panel yesterday, is pushing for one big change in the Actuary’s practices that he says the Panel has also favored: making all the Actuary’s data and methods open for scrutiny by others. “This is a period of big data. When you let other people have access to data, things like Money Ball happen,’’ King said. In addition to new algorithms, he said, the government actuaries need to take note of recent findings about unconscious bias by researchers and apply new methods social scientists have developed to guard against such bias. “Four hundred years ago you had people sitting in a monastery and thinking they thought great thoughts and that was their entire life,’’ King said. “Now we check on each other. If they would leave things open they’d have so much help and they’d be better off politically because their forecasts would be better.”
I'm going to be very brief with my comments. First, Social Security is one of the best programs the United States ever adopted (never mind Stan Druckenmiller's dire warnings). President Roosevelt signed the Social Security Act on August 14th, 1935 and it had a profound effect on the retirement security of millions of Americans ever since (if only the U.S. had signed a universal health bill back then!).

As far as the article above, I'm in no position to verify the accuracy of the reports criticizing the actuarial methods of Chief Actuary Stephen Goss but I do agree that the data and methods need to be open to the scrutiny of others.

Actuaries have a god-like status in the financial world because it's hard to become an actuary. You literally have to pass a series of extremely tough exams and really need to know your stuff when it comes to the assumptions you plug into your models.

But actuaries aren't gods and there are plenty of disagreements among very smart actuaries. I've had discussions with the current and former Chief Actuary of Canada to see how they think and where they agree and disagree. Also, while the Office of the Chief Actuary of Canada prides itself on its independence, the reality is there are political pressures on it, especially when it doesn't toe the ruling party's lines (Canada's former finance minister Paul Martin did a hatchet job on our former Chief Actuary, one of his biggest political blunders ever).

But politics aside, I'm definitely not for privatizing Social Security to offer individuals savings accounts. The United States of pension poverty has to face up to the brutal reality of defined-contribution plans, they simply don't work. Instead, U.S. policymakers need to understand the benefits of defined-benefit plans and get on to enhancing Social Security for all Americans.

One model Social Security can follow is that of the Canada Pension Plan whose assets are managed by the CPPIB. Of course, to do this properly, you need to get the governance right and have the assets managed at arms-length from the federal government. And the big problem with U.S. public pensions is they're incapable of getting the governance right.

So let the academics and actuaries debate on whether the assumptions underlying Social Security are right or wrong. I think a much bigger debate is how are they going to revamp Social Security to bolster the retirement security of millions of Americans. That's the real challenge that lies ahead.

Interestingly, Bernard Dussault, the former Chief Actuary of Canada and a staunch defender of defined-benefit plans and enhancing the CPP, shared this with me on the article above:
All those discussions on the validity of the actuarial valuations on the OASDI programs are unfortunately just a case of "shooting the messenger". Irrespective of the degree of accuracy of the concerned actuarial estimates, the OASDI is actually (and still) in a difficult financial position. The worst aspect of it is the higher (currently 12.4%) contribution rate that will be required as soon as the fund is exhausted in the early 2030s. The current "intermediate" pay-as-you-go rate (13.6% re: http://www.ssa.gov/oact/TR/2014/VI_C_SRfyproj.html#317167 ) already exceeds the 12.4% actual contribution rate and will unavoidably continue to increase until at least 2030 (likely not beyond 2035) to about 18%.
I thank Bernard for sharing this with my readers. Below, CBS 60 Minutes reports on thousands of errors to the Social Security Administration's Death Master File can result in fraudulent payments -- costing taxpayers billions -- and identity headaches.

Keep in mind that 60 Minutes has a few critics who dismiss these reports as hit jobs. As I stated above, I believe Social Security is one of the greatest social programs introduced in the U.S. but it needs to be enhanced so that all Americans can retire in dignity and security.