Retroactive Geniuses And The Pension Benefit Guaranty Corp.

A few days back Josh Marshall inspired howls in the left-o-sphere by flagging a misleading Boston Globe story which suggested (inaccurately) that the Pension Benefit Guaranty Corp. had both approved and implemented a plan to sell bonds and buy stocks at the market peak in February 2008.  In fact, as of Oct 24, 2008 the shift had not been implemented (Millard Congressional Q&A, WaPo, Justin Fox, Alan Krueger).  Lost amongst the shrieks of incompetence and corruption (Krugman - "Why did this happen? I’m sure we’ll find some nasty stuff...") was an interesting policy debate flagged by Justin Fox of TIME:

That still leaves the question of whether moving more of the PBGC's stash into equities is a good idea. The Globe article cites Boston University's Zvi Bodie, who's been arguing for years that retirement savings don't belong in stocks, saying that it's a horrible idea. So there's that. And some of the better-run pension funds have in recent years been shifting from equities into bonds to better match assets with liabilities (I'm thinking here especially of GM's pension fund). But I'm not really clear on what the optimal asset mix would be for a government agency that guarantees pensions into perpetuity and can count on a regular income stream into perpetuity. Are you?

Moi?  Having thought about it, I am still not sure.  But let me paint a bulls-eye on some conventional wisdom.  Here is the cogent Alan Krueger:

It may make sense for universities and philanthropies to pursue an aggressive, diversified portfolio strategy that is heavily weighted toward equities and alternative investments. But it is not clear that such a strategy is optimal for an insurer like P.B.G.C. because its liabilities are also linked to market fluctuations. A philanthropy’s obligations are unrelated to stock market movements. By contrast, when the stock market falls P.B.G.C. gets hit by a double whammy: the value of its assets falls and its liabilities rise, because private pension plans face greater shortfalls when the stock market falls and the financial viability of companies themselves is threatened.

Well, yours truly said that "I'll agree that there is a huge covariance problem", so I don't want to come off as madly disagreeing with this.  But did Prof. Krueger consider the income side of philanthropies when he offered that example?  How are donations holding up in the current climate, or dare we ask?  How about colleges - are their requests for financial aid higher than usual?

However, a few points:

1.  Moral Hazard, or Who Is the Audience:  The PBGC has taken over some failed pension plans and has about $70 billion of pension liabilities.  However, it is also insuring many hundreds of billions more in pension plans of currently ongoing concerns.   If the PBGC is widely viewed as having the backing of the Treasury then companies will be under just a bit less pressure from their beneficiaries to fully fund their pension plans. 

How can the PBGC prevent this gamesmanship?  It can exhort companies to behave responsibly, and it can lobby for legislation to increase its premiums (or to charge risk-based premiums).

But it can also act like an entity that lacks a government guarantee.  Right now the liabilities of the PBGC exceed its assets by about $14 billion.  If the PBGC invests conservatively, it may never close that gap and a bailout at some point down the road may be unavoidable.  Furthermore, if the PBGC invests conservatively it may create the impression that it is resigned to, or reliant upon, such a bailout.

On the other hand, a higher-return/higher risk strategy leads (per their consultant's study) to a higher probability of avoiding a bailout.  One can easily imagine that the higher-risk strategy could result in both a reduced probability of a bailout and an increase in the expected value of a bailout should one be necessary. 

And that might be OK - Congress and the Administration may have concluded that the $60 odd billion currently under PBGC management is chump change relative to the hundreds of billions of private pensions that are watching the PBGC for signs of a government guarantee, and may have quietly exhorted the PBGC to focus on minimizing the probabilty of a bailout, not the expected value of one. 

For example, the political calculation may have been made that a 90% chance of a $5 billion bailout is less attractive than a 30% chance of a $25 billion bailout, given the likely influence on the behavior of private plans.  People may disagree with that judgment, but it is neither crazy nor criminal.  [Note - an easy way to model that would be to assume a fixed bailout cost that is incurred regardless of the size of the bailout.  E.g., suppose all bailouts incur $25 billion in moral hazard costs and recalculate the expected values in the example above.  A 90% probability of $30 billion in total costs has a greater expected value than a 30% chance of $50 billion in total costs.]

2.  Beware of Retroactive Geniuses.

Sure, right now it is obvious to all and sundry that switching out of bonds to buy stocks in February 2008 was a bad idea, and that holding long term Treasuries would have worked out brilliantly.  But not so long ago the real fear was that the US economy would crumble when the financial Twin Towers collapsed - our trade deficit and budget deficit would become unsupportable, foreigners would dump their vast Treasury holdings, US interest rates would go sky-high, and the US dollar would accompany the US economy into the wastebasket.  (Is there a Nobel Laureate in the house to verify this fear?)

And had that scenario come to pass, my guess is that the same group of pundits thumping the current PBGC decision would marvel that anyone could be so incompetent or corrupt as to have held onto Treasuries.  Well, assuming that the investment manager was a Republican.

Or for another scenario, what about stagflation, caused perhaps by an oil shock?  How would the Treasuries-only approach have fared then?  Really, really well, or not-so-good?  Maybe having a few investments in oil and gas partnerships among the 10% of the portfolio devoted to exotics would have helped ease the pain.

In any case, in assessing the PBGC strategy it is not helpful to explain that Treasuries will almost surely outperform equities in the six or twelve months before a recession.  The relevant question is whether equities will outperform Treasuries by enough during the good times to leave a comfortable cushion during the bad times.  For example, even though the PBGC equity fund was down a ghastly 23% for the year ended Sept 30, 2008, it had managed to outperform the bond fund for the full five years before that date.  I am sure that did not hold up through Dec 31, but maybe basing all policy on the hundred year financial flood is not so wise either.  

I don't have a table-pounding conclusion here.  But the PBGC consultants did attempt to look at the interplay of economic scenarios, asset performance and new bankruptcies, so the question is hardly untouched.  The CBO also joined in.

And Mr. Orszag, hailed by Ezra Klein as "a prophet" was a bit more ambivalent in his reply as Director of the CBO when he commented on the new, riskier strategy.  He noted the likely coincidence of bankruptices and poor portfolio performance, but also wrote this (my emphasis):

The effect on taxpayers of PBGC’s new investment strategy will depend on policymakers’ response to that strategy. If the new investment policy does not cause the government to lower premiums or raise benefits relative to what otherwise would occur, taxpayers should be largely indifferent to the choice of a riskier investment strategy because the higher expected returns will compensate for the greater risk. Conversely, taxpayers could expect to be worse off if, in response to the new investment strategy, policymakers convey some of the benefits of greater returns to other stakeholders, increasing taxpayers’ exposure to any losses that PBGC might incur.

Orszag identifies yet another dimension to the moral hazard problem - if the PBGC gets into surplus, as it did during the Clinton bom, there will be pressure for premium cuts.  groan.

How the PBGC should be investing is a tricky question.  Let's see if the analysis can get more thoughtful than this, from Krugman:

Why did this happen? I’m sure we’ll find some nasty stuff, but at least part of the reason was that the Bush administration, like many conservatives, was under the spell of the following pseudo-syllogism:

1. The stock market captures the essential spirit of capitalism.

2. Capitalism roolz!

3. Therefore, stocks will go up.

I'm sure that was the thought process.  Oddly, I am certain that Krugman typed that while proudly wearing a "Nationalize the Banks - Sweden Roolz!" t-shirt.  Speaking of which, have any of the "Nationalize Now!" crowd ever responded to Justin Fox's point that roughly 75% of Citigroups's $2 trillion in assets and liabilities are on foreign shores, away from the interests (and probably the legal reach) of the Hard Working American Taxpayer?

ASIDE:  Still no follow-up from Krugman on how a proposed but not implemented change in investment strategy by a $63 billion fund "left us all a gratuitous loss of hundreds of billions", but we aren't expecting one.  Move on, indeed.

[end of thread]

Comments

[TM]

I CAN QUIT ANYTIME

Just FYI, this is the first time in my adult life I have read more than three pages of a pension fund report without falling into a coma.

But I understand that not everyone may be having a similar breakthrough moment...

[clarice]

I suppose there'd be no covariance if they only bought shorts. *ducking*

[jorod]

Are there any Clinton Appointees at the PBGC?

Seriously, after the PBGC takes over a pension plan, it should fully fund the plan according to GAAP and then transfer it to a private trustee such as a bank or other trust company. Just like the FDIC sells a failed bank. It could raise money by selling the stream of trust fees to a successor trustee. Get the government out of the pension/investment management business.

[Karl]

BTW, Krugman is also wrong about when the oil shocks started. When Nixon took the US off the gold standard, OPEC decided it still wanted the same amount of gold per barrel, however many inflated US dollars that might be.

[Appalled]

TM:

An observation to your first point -- the amount of contributions to a pension is a matter of income tax regulation. there is a minimum amount -- there is also a rarely reached maximum amount. Moral hazard, or no, companies usually opt for the required minimum contribution. (And, given the impact a PBGC insured plan has on a corporate balance sheet, there already is a lot of moral hazard baked into the system.)

The government has, over the years, tried to improve funding by introducing risk based premiums to the PBGC and increasing the required miniumum contributions. The result, combined with accounting standards that may pension underfunding a balance sheet iteme, has been a large decline in number and coverage of pension plans. (The old fashioned db pension only covers 17% of the workfporce, and many of those are government workers, who are not covered by PBGC insurance.)

jorod -- Do you have any idea what it costs to "immediately fully fund" an underfunded pension plan the PBGC takes over? If you want to bust the PBGC trust fund really quickly, that's the way to do it!

[TM]

Moral hazard, or no, companies usually opt for the required minimum contribution.

This will give away my age but I vaguely remember a time when companies that had overfunded their pension plan would become takeover bait - apparently the acquirer could restructure the plan and reclaim pension assets.

[Appalled]

Overfunding was and is often a function of asset performance, rather than contribution history.

Um, I won't give away your age by mentioning when the laws that made that a worthwhile technique were changed. Because that might give away my age, too.

[Jane]

This will give away my age

Only to a very peculiar group of people.

Myself excluded.

[Bill in AZ]

Sort of OT, but this is a money thread and a genius thread...

When I woke up this morning to the genius Soros Reflexivity Network (ABC News), it struck me the that first and only story before the first commercial had to do with the Mark to Market accounting rules change. I wondered about the timing. Now, probably less than 1% of listeners would even have a clue what that story was about - but the less than 1% who do apparently reacted properly. In spite of another 700k of job losses (that got no mention), the market climbed today, with various top headlines associating the rise with Duh Won's incredibly successful G20 summit.

There is no need to connect dots - they all line up and connect themselves, day after day.

[clarice]

OT--thanks--I was so busy with other things I missed it. In case anyone else did, here's a story about it:

http://features.csmonitor.com/economyrebuild/2009/04/02/key-change-in-accounting-may-boost-banks-balance-sheets/>Mark to market finally gets tossed

[RichatUF]

Bill-

I was thinking along those lines the other day-pretty convenient that FASB, OCC, and SEC spent all that time putting the mark to market regime in place then when it all went bad because of "information asymmetries" they quickly put in an HFV patch-problem solved. Another rule change coming down the pike is the uptick rule.

However, and I'm not sure where I would look to either prove or disprove my hypothesis, is that AIG is unwinding its books and if they were bailing on securities, commodities, and currencies positions, regardless of there profitibility, enough people on trading desks might know what is going on and are front running the trades.

[Charlie (Colorado)]

I suppose there'd be no covariance if they only bought shorts. *ducking*

Insert "underwear gnomes business model" joke here.

[Charlie (Colorado)]

I wondered about the timing. Now, probably less than 1% of listeners would even have a clue what that story was about - but the less than 1% who do apparently reacted properly.

Bill, that's been discussed for weeks, and the date of the FASB meeting at which it'd be voted has been known for a long time. It's been treated as fait accompli for at least a week, and people last night were talking about which stocks to watch when it happened as it inevitably would.

Make sure you're connecting dot with a line, and not drawing the line first.

[clarice]

Shoot,Chaco, you are really trying to make it hard for folks like me to find patterns.

[Charlie (Colorado)]

I was thinking along those lines the other day-pretty convenient that FASB, OCC, and SEC spent all that time putting the mark to market regime in place then when it all went bad because of "information asymmetries" they quickly put in an HFV patch-problem solved. Another rule change coming down the pike is the uptick rule.

Jeez, guys. The accounting changes were discussed and driven by Enron, which filed bankruptcy in December 2001. FAS 157 was proposed not too long after that, issued in September 2006, effective in fiscal years that start after November 15 2007. In other words, it wasn't forced on people, effectively, until 2008 -- who has a fiscal year that starts on 1 December?

FASB had been pushed to change 157 gain starting last year, and it took until 1 April to happen. The only surprise here is that a rule that took 3-4 years to propose issue, and adopt could be changed in 6 months.

[Charlie (Colorado)]

Shoot,Chaco, you are really trying to make it hard for folks like me to find patterns.

Yeah, I know, what a party pooper.

[Chris]

So, the left goes nuts about the PBGC's (discussion of) altering its investment allocation to include 25% in equities from the prior 10% (I think those numbers are correct, working from memory).

Same leftys are apoplectic over simply discussing letting individuals retain their own social security accounts and invest a portion of it. Risky scheme! Never mind that the investments being proposed were treasury accounts. The left wailed and railed that Rethug's wanted to put grandma's retirement $$ into Enron.

Why do they hate markets and worship government? I don't get it.

[Bill in AZ]

Charlie, for someone who pays attention to stuff like this, yes, it is known. But it is a small circle of people who have actually retained the term if they heard it anywhere, and a smaller circle who even have a clue or care about what it means. ABC News, with commercial breaks, etc, has maybe 3 minutes worth of news on the hour. Why would they devote a minute of that to Mark to Market to the 99% of listeners who have no clue what it is. It was aimed at the semi-knowledgeable, who have heard it is a good thing, and they reacted appropriately today.

[clarice]

OT:Tedisco ahead--not by much :"As voting machines are re-canvassed, Assembly Minority Leader Jim Tedisco has picked up 37 votes, evaporating Democrat Scott Murphy’s lead in the race to replace Kirsten Gillibrand in Congress, according to county election officials who are conducting a recanvass. "

Tedisco now has 77,236; Murphy has 77,224.

http://www.freerepublic.com/focus/f-news/2221014/posts

[Charlie (Colorado)]

Bill, my point is it's really hard to have a secret cabal running an illicit conspiracy if everyone knows about it.

It would be nice if the general press sovered these things a little ahead of time, but frankly, I doubt they understood it either.

[clarice]

Blagojevich and his brother indicted (75 pp indictment) no word as to whether we will be treated to another of those super duper Fitzgerald pressers.
http://www.suntimes.com/news/metro/blagojevich/1508772,rod-blagojevich-indicted-040209.article>Indictments

[centralcal]

In other semi-good news from Malkin re: Ward Scumbag Churchill:

"In Denver, the verdict in the Ward Churchill trial was just read.

The jury found that University of Colorado terminated him based on his speech, but awarded him $0 for past economic harm and $1 for current damages."

[Chris]

I look forward to working the name "Tedisco" into many future conversations. Hoping he hangs on.

[clarice]

I wouldn't dance around Denver yet--The Court might still reinstate this fraud. (And don't blame the jurors or the judge, blame CU which hired him, kept him on and took its good time to act on the well-founded claims that he is an academic fraud.

[centralcal]

Clarice: That is why I said it was semi-good news . . . at least he wasn't awarded any past or present monetary damages!

I assumed that if the court found he was wrongfully terminated that CU would be forced to hire him back? Is that how it works?

[Bill in AZ]

It's neither a "secret cabal" or an "illicit conspiracy", well, except to its target, the vast muddle. The whole point of Soros "reflexivity" and the JournoList Fascist Directives is that it is right in the open. It wouldn't work otherwise.

Soros "Reflexivity" is to nudge markets through words, action, money if necessary, usually all three. Then, when the market takes on a life of its own, you catch the fallout - whatever that is. The same people who don't know what Mark to Market or FASB are, will freely associate todays market uptick to Duh Won's successful G20 summit - with the help of the media of course.

[clarice]

Often, cc..

[Porchlight]

OT,

This sucks: Obama to nominate sampling expert to head census

The left has wanted sampling aka polling in the census for years, so this is no surprise. High stakes for 2012 races.

This appt requires Senate confirmation - I don't suppose the Repubs have a chance, but I hope they'll at least try.

[Jane]

The jury found that University of Colorado terminated him based on his speech, but awarded him $0 for past economic harm and $1 for current damages."

I hope it sticks. Churchill is scum.

[bad]

Churchill is scum.

Scum doesn't deserve that.

[Jim Rhoads a/k/a vjnjagvet]

Maybe the jury thought that the University of Colorado enabled Churchill. Or that they deserved each other for a while longer.

Anyone want to take bets on how long it will be before he gets fired again?

[Boatbuilder]

An interesting letter in the WSJ from Roger Bowen, who I recall as a very lefty professor of Government Studies at Colby College a long time ago. Bowen says that Churchill is a fraud, but that he was hired by Colorado "largely because of his reputation as a provocateur;" Bowen suspects that "Churchill understood . . . that he had been empowered to bolster the university's reputation by being outspoken and outrageous." They deserve each other--but do the taxpayers, students and parents who pay for it all deserve to be saddled with the bill? Shouldn't the University fire whoever hired him in the first place?

[Stephanie]

So the editor of the NY Slimes says that saving the paper ranks right up there with saving Darfur...

Works for me. Lots of lip service and the situation doesn't improve, but hey! the libs feel better about themselves for having cared.

[AL]

Lefties are making great disservice to PBGC, trashing their plans to purchase stocks. Now it is good time to invest in stock market. In last two days Chinese bought US automotive parts company and stake in Canadian oil sand company, for example.