The siege of America’s public-fund money really began nearly 40 years ago, in 1974, when Congress passed the Employee Retirement Income Security Act, or ERISA. In theory, this sweeping regulatory legislation was designed to protect the retirement money of workers with pension plans. ERISA forces employers to provide information about where pension money is being invested, gives employees the right to sue for breaches of fiduciary duty, and imposes a conservative “prudent man” rule on the managers of retiree funds, dictating that they must make sensible investments and seek to minimize loss. But this landmark worker-protection law left open a major loophole: It didn’t cover public pensions. Some states were balking at federal oversight, and lawmakers, naively perhaps, simply never contemplated the possibility of local governments robbing their own workers.
Politicians quickly learned to take liberties. One common tactic involved illegally borrowing cash from public retirement funds to finance other budget needs. For many state pension funds, a significant percentage of the kitty is built up by the workers themselves, who pitch in as little as one and as much as 10 percent of their income every year. The rest of the fund is made up by contributions from the taxpayer. In many states, the amount that the state has to kick in every year, the Annual Required Contribution (ARC), is mandated by state law.
Chris Tobe, a former trustee of the Kentucky Retirement Systems who blew the whistle to the SEC on public-fund improprieties in his state and wrote a book called Kentucky Fried Pensions, did a careful study of states and their ARCs. While some states pay 100 percent (or even more) of their required bills, Tobe concluded that in just the past decade, at least 14 states have regularly failed to make their Annual Required Contributions. In 2011, an industry website called 24/7 Wall St. compiled a list of the 10 brokest, most busted public pensions in America. “Eight of those 10 were on my list,” says Tobe.
But for all of this, state pension funds were more or less in decent shape prior to the financial crisis of 2008. The country, after all, had been in a historic bull market for most of the 1990s and 2000s and politicians who underpaid the ARCs during that time often did so assuming that the good times would never end. In fact, prior to the crash, state pension funds nationwide were cumulatively running a surplus. But then the crash came, and suddenly states everywhere were in a real, no-joke fiscal crisis. Tax revenues went in the crapper, and someone had to take the hit. But who? Cuts to corporate welfare and a rolled-up-newspaper whack of new taxes on the guilty finance sector seemed a good place to start, but it didn’t work out that way. Instead, it was then that the legend of pension unsustainability was born, with the help of a pair of unlikely allies.
In fact, Baker said, had public funds during the crash years simply earned modest returns equal to 30-year Treasury bonds, then public-pension assets would be $850 billion richer than they were two years after the crash. Baker reported that states were short an additional $80 billion over the same period thanks to the fact that post-crash, cash-strapped states had been paying out that much less of their mandatory ARC payments.
So even if Pew’s numbers were right, the “unfunded liability” crisis had nothing to do with the systemic unsustainability of public pensions. Thanks to a deadly combination of unscrupulous states illegally borrowing from their pensioners, and unscrupulous banks whose mass sales of fraudulent toxic subprime products crashed the market, these funds were out some $930 billion. Yet the public was being told that the problem was state workers’ benefits were simply too expensive.
Now why would groups want to trumpet these problems. Well, there’s a huge amount of money involved and where there’s money there are grifters:
One of the most garish early experiments in “alternative investments” came in Ohio in the late 1990s, after the Republican-controlled state assembly passed a law loosening restrictions on what kinds of things state funds could invest in. Sometime later, an investigation by the Toledo Blade revealed that the Ohio Bureau of Workers’ Compensation had bought into rare-coin funds run by a GOP fundraiser named Thomas Noe. Through Noe, Ohio put $50 million into coins and “other collectibles” – including Beanie Babies.
The scandal had repercussions all over the country, but not what you’d expect. James Drew, one of the reporters who broke the story, notes that a consequence of “Coingate” was that states stopped giving out information about where public money is invested. “If they learned anything, it’s not to stop doing it, but to keep it secret,” says Drew.
Hedge funds have good reason to want to keep their fees hidden: They’re insanely expensive. The typical fee structure for private hedge-fund management is a formula called “two and twenty,” meaning the hedge fund collects a two percent fee just for showing up, then gets 20 percent of any profits it earns with your money. Some hedge funds also charge a mysterious third fee, called “fund expenses,” that can run as high as half a percent – Loeb’s Third Point, for instance, charged Rhode Island just more than half a percent for “fund expenses” last year, or about $350,000. Hedge funds will also pass on their trading costs to their clients, a huge additional line item that can come to an extra percent or more and is seldom disclosed. There are even fees states pay for withdrawing from certain hedge funds.
You won’t be surprised to learn that these fees are much higher than more traditional money managers.Let’s put the amount into context:
In public finance, hedge funds will sometimes give slight discounts, but the numbers are still enormous. In Rhode Island, over the course of 20 years, Siedle projects that the state will pay $2.1 billion in fees to hedge funds, private-equity funds and venture-capital funds. Why is that number interesting? Because it very nearly matches the savings the state will be taking from workers by freezing their Cost of Living Adjustments – $2.3 billion over 20 years.
and they don’t actually do any better:
In 2008, Warren Buffett famously placed a million-dollar bet with the heads of a New York hedge fund called Protégé Partners that the S&P 500 index fund – a neutral bet on the entire stock market, in other words – would outperform a portfolio of five hedge funds hand-picked by the geniuses at Protégé.
Five years later, Buffett’s zero-effort, pin-the-tail-on-the-stock-market portfolio is up 8.69 percent total. Protégé’s numbers are comical in comparison; all those superminds came up with a 0.13 percent increase over five long years, meaning Buffett is beating the hedgies by nearly nine points without lifting a finger.
Well, the states don’t have the money so they have to cut pensions. There’s no other place they can find such large sums of money. Right?
“This whole thing isn’t just about cutting payments to retirees,” says syndicated columnist David Sirota, who authored the Institute for America’s Future study on Arnold and Pew. “It’s about preserving money for corporate welfare.” Their study estimates states spend up to $120 billion a year on offshore tax loopholes and gifts to dingbats like Schilling and other subsidies – more than two and a half times as much as the $46 billion a year Pew says states are short on pension payments.
One of the main players in this is John Arnold who got his start at a company called Enron (you might remember them). Who is John Arnold? Why a billionaire hedge fund manager–let’s look at a nice hagiography:
It was at the Houston energy company, under the tutelage of a stellar roster of traders, that Arnold really blossomed, becoming a well-paid star in the late 1990s. On Enron’s natural-gas trading desk, which handled contracts totaling more than $1 billion a day, when he was only in his mid-twenties, Arnold alone reportedly earned Enron nearly $750 million in 2001. One colleague dubbed him the “king of natural gas.”
After the accounting scandal brought down the company (the fraudulent schemes had little to do with Enron’s legitimate trading business), UBS bought the trading team and gave Arnold an $8 million bonus to stay. But he left, and eventually recruited former superiors like Greg Whalley, the last president of Enron, and trader Mike Maggi to reassemble a rump Enron team at Centaurus. He has also cherry-picked traders from other firms that have blown up.
You wouldn’t know it from this, but one of the main ways Enron made its money was by manipulating the energy market and that’s what Arnold did. go back to the Taibbi article:
In fact, in the book that the movie was based on, the authors portray Arnold bragging about his minions manipulating energy prices, praising them for “learning how to use the Enron bat to push around the market.” Those comments later earned Arnold visits from federal investigators, who let him get away with claiming he didn’t mean what he said.
That $8 million bonus was used to hire other traders who had been involved with companies that committed fraud (of course, they are all clean) and he’s now a billionaire. Isn’t this country great?