Pension Funds: The Real Problem

Pension Funds: The Real Problem
<small><em>Photo</em> by <a href="" target="_blank">stevepb</a> (<a href="" target="_blank">Pixabay</a>)</small>

Pension Funds: The Real Problem

Pension Problems are Not Exclusive to the US

The real serious thing is not that the pension funds can’t keep their promises. Your “golden years” will not be as luxurious as hoped; but less will do.The real problems are:


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A) The dynamics:


1) In the desperate attempt to meet their obligations the funds will throw themselves into very risky investments. These risky investments will be bidden down in their promised ROI; but the risk will be the same. Let’s say a project has a 1 in 10 chance of flopping in the coming year – every year, the risk alone should demand a ROI of 10%; but as there is so many investors desperate investors this ROI is bidden down to – say – 5%. In the larger scheme of things 100 of such investment opportunities will have 10 flops – not withstanding the official ROI says only 5. But to the investors will get not a big round 0 ROI – as supposed, they will get a -5% ROI.

2) The more money chasing high ROI the more high risk investment opportunities will pop up. The higher the demand for junk is, the more junk is produced. But junk is junk. The bigger the demand for losing money, the higher the loss of money is.

3) The more risky projects that are financed the higher the investments in the economy is. That might save some of the low risk (but still with underrated risk) projects. If there are a lot of snake oil projects – raising snakes might just be a good idea – and profitable if closed down in time. But as these investments really are really consumption – because in the end they will end up with Ponzi-schemes. An investment that can’t serve principal – no matter what the interest rate might be – is to some extend a loss.

4) Another danger to society is that these high risk investment projects will crowd out the low risk, low yield investments. F.i. some public investments as – say a new road – whose tollbooth takings will never give a ROI of more than slightly above the sovereign bond interest rate. But that road will benefit the community in a way that isn’t recorded. The users still pay the toll though there are probably free alternatives.

B) The hidden fraud:

As long as the annual payments into the pension fund exceeds payments out the fund the value of the future obligations are more or less irrelevant – in the true Ponzi-scheme fashion. As long as you can keep the liquidity flowing very few cares about solidity. The problem arise – as with all Ponzi-schemes – when inflow of money does not match outflow.

Inflow of money to a pension fund will suffer from raising unemployment – the outflow is unaffected by unemployment. This means dipping into principal – or at least not reinvesting money when bond etc. are paid out at maturity. If the investments have been made according to modest promises that won’t be to big a problem: The pension fund will just wind down as people die and bonds reach maturity.

But if – and when – the inflow due to return on the investment fails shares and bonds (after losses) do not yield 8% annually, but only ½%, then the demands for inflow to meet outflow is raised still further (another characteristic of the Ponzi-scheme). Unfortunately the two scenarios are interconnected: When inflow is hamstrung due to falling employment, then inflow due to interest payments and low profits is liable to occur simultaneously.

Outflow also have a tendency to rise: People are not dying as they used to. There is a great difference between paying to a retired person for 10 years and 20 years. Secondly the promises made to the savers have a tendency to be optimistic to attract business.

Now most legislation is aware of the Ponzi-scheme danger. It thus require the promised yield to be reserved to each saver annually on line with their current savings payments. To ensure coverage the future obligations are discounted to a present value which must be met by the balance of the savers account. Now that is selling elastic by the yard. By juggling the discount rate you can almost always make the twain meet. Raising the discount rate is a warning of impending collapse – people do get older and business is not booming. In Denmark the reason is that peoples life expectancy grows about 3 years pr. decade – i.e. you will probably be 5-10 years older when you die than your farther. (And then you tax booze and cigars! Two things that really chops life expectancy in the expensive end! Irresponsible politicians – so inconsiderate to the financial community!). Raising the discount rate is probably the only thing that can really whack these remote payments: The present value of a dollar to be pay in 30 years at a discount rate of 8% only has a present value of 10 cents.

Entering into speculation:

The reason for the discrepancy between the Danish panic rate of 5% and the US ditto of (as Jacob Wolinsky mentioned) 8% could be an outdated (pension funds are always half a century out of date) concept of african-americans.

In the first place: That type of citizens are not likely to make pension savings in the first place, but they do drag down life expectancy. So the easy money for the pension funds aren’t rolling in – due to premature deaths.

Secondly: Without detailed knowledge I do assume that there are a lot of solid descent african-americans, that are just americans: They save for their old age, they hold nice respectable and steady jobs, they lead normal healthy lives where the greatest risk is choking on the spare ribs from the barbecue.

Why do I guess that? Experience from Denmark shows that pension funds stick to outdated stereotypes – again outdated by 50 years. In 2008 they had to raise the discount rate because to the horror of the Central Bank the life expectancy had not been revised in 20-30 years. They still hadn’t found out that pensioners were not going to be people born before WW1 with deprived childhoods, they had not had the steady alcohol consumption in the workplace (alcoholics don’t retire – they die – and they don’t save), suffering from the crisis of the 1920’ies and 1930’ies – they were not traumatised by war (post traumatic stress disorders have the pleasant – for the pension fund – tendency to commit suicide), they had not worked the industrial poison pits of the 1950’ies, they had lived in nice healthy suburbia with free dental care.

That is what makes ATP so frighting:

1) As administrators they have not made any promises – except that they will do their best. They are not exposed to competition for their payments. By law they get a small – and it is small – monthly payment from every pay check. They don’t have to make promises they can’t keep – just to survive.

2) They have concentrated on not running risks that weren’t covered by realistic budgets. They receive lots of applications for funds – and are under constant political pressure to “invest”; but they have dismissed it with documentation that those underfunded entrepreneurs simply aren’t there: There is a difference between running a risk and being naive.

3) It doesn’t mean that they are adverse to making a killing. I 2008, when the CB got caught on the wrong foot, they had a nice stack of German sovereign bonds that the CB desperately needed – so they parted with them – at a price. From the smug grin on the CEO’s mug – a
considerable price.

4) When the government wanted to “kickstart” consumption and pay out an old fund (nobody remembered where that came from anyhow) to the savers – they did so with a smile: They apparently had not investment projects at hand – not something viable – to place those money in anyhow. They bowed to pressure to “invest” in the dead FIH bank and mortgage bank, and was prevented from going into banking – by political pressure from the banks. That backfired into the governments face as they – to raise liquidity – started to call home loans from insolvent speculators. That threatened to foreclose on the speculative developers and a sell off into an already depressed market. The banks not only risked seeing their debtors end up in bankruptcy court – they risked all their collateral due to a sell of. The government had to step in and relieve them of their dubious real estate loans – just to keep the entire financial sector from falling flat on their face.

5) They have expressed interest in financing infrastructure. Something that is not hugely profitable, but safe – a bridge is not likely to elope to the Cayman Islands all by itself.

6) After making a few killings they were able to transfer money to the savers reserved accounts so they could meet obligations – nice way to get your carefully hoarded reserves away from greedy government fingers.

Generally the ATP has done the exact opposite of all the other pension funds.- in every respect.

The result has been that in 2007 they administrated 1/6 of the pension funds in Denmark. That grew to 1/4 in 2008. Dropped slightly to a bit more than 1/5 in 2009 due to payouts on obscure funds for a “kick start”. But in 2010 they were back up to 1/4. Partly due to the conversion of fixed rate mortgage bonds – money that naturally wasn’t “invested” into flexible rate mortgage bonds. The latest – unattributable figures I’ve seen for 2011 – are 1100 bio. DKK out of 3000 bio. DKK in total pension savings – or a bit over 1/3 of the pension fund savings.

We are talking landslides in financial power.

This is likely to go on:

a) Those involved in the tax arbitrage of taking a loan with flexible interest and pay in on a pension scheme (fully tax deductable) are likely to be squeezed into reducing their insolvent house loans. That might indeed be one of the reasons why Danske Bank has put Danica Pension on the market. How much money are we talking about? Haven’t the foggiest notion. But I do read the CEO of the Danish CB (colloquially called “Uncle Nils” as everybody hocks their junk at his place) statement of today:

PDF Link:

“….. the losses of the Financial Sector on households have up to now been modest. This is particularly due to the fact that persons with high debt also have large assets in among other things pensionsavings, shares and bond – plus dwellings.”

Such tingling optimistic tones are normally the prelude to cruel and violent action.

b) ATP has publicly announced that their emphasis is NOT on earning money; but on avoiding losing them. A corollary to this is (as ATP generally do the opposite of the rest) that the other pension funds are losing money hand over fist. The wide eyed glare and clenched jaws of the CEO’s of the other funds support this supposition.

c) There are a number of big infrastructural investments (HTDC power-network, tunnel to Germany f.i.) that can hardly be financed directly by taxation, but will have to be “leased”. The government is in a bind: Without easing taxation to many home owners will have to foreclose.

d) ATP is not involved in excessive saving and speculation: The high debt households that have shares are liable to get a beating if they have financed their “investment” in shares with a loan in their house. The “investment” is dubious and the debt is uncovered at a low interest rate.

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