Rolling Stone – my subscription to which lapsed in the 11th grade – has a long and conspiratorial article by Matt Taibbi arguing that funding problems for public employee pensions – as well as the drive to reform these plans – are intimately connected with public plans’ growing holdings of “alternative investments,” namely hedge funds and private equity.
Taibbi’s article is apparently intended for the (presumably small) intersection of readers who both are interested in pension financing yet also drawn to Taibbi’s use of the F-word (edgy!) and his juvenile insults, such as referring to think tank-funder John Arnold as “a lipless, eager little jerk with the jug-eared face of a Division III women’s basketball coach,” and Curt Schilling as a “Christ-humping ex-Red Sox pitcher.”
Others have run through some specific issues with Tiabbi’s argument, but what strikes me is its basic illogic. Taibbi’s thesis is apparently a) the high fees charged by hedge funds are ripping off public pensions; and b) think tanks and other groups are pushing to shut down DB pensions. I’m not sure whether either of these claims is true, but the problem is that – as Taibbi goes to lengths to argue – these shadowy groups are themselves supported by current or former hedge fund managers. In other words, the very people Taibbi claims are profiting the most from the public pension gravy train – and profiting they are, as public plans are the largest single investors in hedge funds and private equity in the country – are the ones trying to stop it. My spider-sense tells me the story might be a little more complicated than Taibbi lets on.
The reality, as I read it: the viability of most public plans depends on generating investment returns on the order of 8% per year. For each percentage point the return falls, funding costs rise by around 20%. In the past it was easy to get 8% returns– for instance, yields on long-term Treasury bonds in the 1980s approached 8% – but not when long-term interest rates are less than 4%. Simply holding stocks won’t do it, since these are clearly too risky for plans that desire contribution stability from year to year. Hedge funds, by contrast, promise higher returns than stocks but with risks that are often poorly documented and, in any case, generally not disclosed to the public. But if hedge fund investments make an assumed 8% return plausible, everyone – meaning elected officials, public employee unions, and (today’s) taxpayers – is happy.
The real issue isn’t one interest group trying to rip off another. It’s a more familiar but less reader-friendly story of present generations profiting at the expense of future ones. The true costs of public plans are roughly double those reported based on assumed 8% returns. If we don’t pay those costs upfront, someone is likely to bear them down the road.