Creating Pension Plan Chaos for Teachers, Firefighters, and Cops

A single butterfly flapping its wings, chaos theory tells us, can wreak social havoc. Those flaps could alter the course of a tornado two weeks later. A big deal if your home happens to be in that tornado’s new course.

Now if a single butterfly could wreak such havoc, imagine the damage a few flaps by America’s super rich could wreak. We don’t have to imagine, suggests a new report from the Center for Retirement Research at Boston College. We just have a trace the recent history of America’s pension funds for state and local government employees.

Our story starts decades ago, in the middle of the 20th century, an era in the United States much more equal than today. One prime driver of that greater equality: high taxes on high incomes, as high as 91 percent on joint return income over $400,000.

A good many of America’s rich took these stiff tax rates as a direct personal affront, and they labored and lobbied mightily to “reform” the tax code. By “reform,” they meant cutting taxes on the nation’s most financially favored. Eventually, they succeeded.

This “success” — the tax rate on top-bracket income dropped from 91 percent to 28 percent in the quarter-century after 1963 — didn’t just put more dollars into the pockets of rich people. The tax cuts for America’s rich would end up taking dollars away — decades later — from average Americans.

Let’s follow the flapping. The initial tax cuts the rich started winning over the closing decades of the 20th century put a budget squeeze on state and local governments all across the United States. With revenues pinched, once-routine budget outlays — like dependable and adequate funding for government employee pension plans — suddenly came to be seen as budget extravagances.

Up until then, public employee pension plans had always been conservatively managed affairs. Government bodies made annual contributions to these plans, and the plans put these contributions into rock-solid investments that promised a regular if modest return. Nobody involved made grand fortunes off this pattern. Everybody involved could look forward to a secure retirement.

But in the new emerging don’t-tax-the-rich era, this old gameplan didn’t work anymore. Fiscally squeezed state and local governments simply began reneging on their pension responsibilities. They stopped making healthy annual contributions into public employee pension funds.

That contribution cutback, in turn, put enormous pressure on pension plan managers. With contributions down, plan managers could no longer be content with safe, conservative investments that delivered modest annual returns. They needed high returns to make up for cutbacks in government pension plan contributions.

Pension plan managers found these magical high returns in the world of hedge funds, private equity, and commodity speculation, the financial universe of “alternative investment strategies.”

Hedge funds had begun as financial boutiques for super-rich Americans suddenly flush — thanks to tax cuts — with beaucoup dollars available for investing. Hedge fund managers competed for those dollars by promising ever higher investment returns — and they delivered on those promises, mainly by mixing new-fangled high-tech market analytics with old-fashioned insider-trading.

The delivering would be extraordinarily lucrative — and easy — for hedge fund managers. They charged astoundingly high fees and had no problem giving their wealthy clients good value in return. In those early days of “alternative investments,” hedge fund chiefs had plenty of low-hanging fruit to pick.

But hedge fund managers — and their private equity and commodity speculation brethren — yearned for more. America’s richest households had tens of millions to invest, the alternative investment crowd realized. But America’s public employee pension plans had billions.

In an America growing increasingly unequal, these pension plans and hedge fund managers needed each other. The hedge fund crowd needed new markets. The pension plans desperately needed high returns on their investments.

What happened next? The Center for Retirement Research at Boston College takes our story up to the present day in a just-released new report, A First Look at Alternative Investments and Public Pensions.

In the early years of the 21st century, the Boston College researchers relate, state and local government pension plans began investing an ever greater share of their assets in alternative investments. Between 2005 and 2015, the level of these riskier investments nearly tripled, going from 9 percent of total public employee pension plan assets to 24 percent.

Some state and local public employee pension plans even put most of their money in alternative investments. The Dallas police and firefighter plan, for one, had funneled 68 percent of its investment dollars into risky alternative investments by 2015.

All these new dollars invested in “alternatives” made hedge fund managers and their pals major personal fortunes. But these alternative investments did not deliver the high returns that pension plans for teachers, firefighters, police, and other government workers had expected.

In fact, note analysts at Yahoo Finance, public employee pension plans have lost an estimated $624 billion over the last 10 years, a free-fall that reflects both the high fees these plans pay to alternative investment managers and the poor performance these investment managers have delivered.

The result: increased retirement insecurity for millions of local and state government workers — and more budget cuts for schools, hospitals, and libraries as local and state governments scramble to meet their pension obligations.

None of this likely “ends particularly well,” predicts Scott Kubie, the chief investment officer at the financial management firm Carson Group.

Except for America’s rich. They flap. We flounder.

Sam Pizzigati co-edits Inequality.org. His latest book, The Case for a Maximum Wage, has just been published. Among his other books: The Rich Don’t Always Win: The Forgotten Triumph over Plutocracy that Created the American Middle Class, 1900-1970. Follow him at @Too_Much_Online.