“The headlines read, ‘These are the Worst of Times.’ I do believe that’s true.”
So lamented Styx lead vocalist Dennis DeYoung in a song he wrote and recorded in 1980. To listen to the lyrics, the ballad would seem inaptly titled “The Best of Times.” But then, love conquers all. That’s where the ‘best’ part comes in, as two star-crossed lovers find in each other their salvation from a world turned cruel.
The song was the first release from Styx’s 1981 triple-platinum album Paradise Theatre. That first release suggests the album could just as well have been named Paradise Lost. It’s impossible to say without asking DeYoung directly but perhaps his somber tone was simply a reflection of the times.
Seth Klarman's Baupost is one of the largest hedge funds in the world, and it utilizes a long-only, value-focused investment process. However, some well-known names have suggested that value investing is dead, so where does that leave Baupost and other highly reputable value investors? Klarman had some insight in his year-end letter for 2021. Q4 Read More
The oil crises of the 1970s had left the country mired in stagflation and veering headlong into a double recession. Inflation and unemployment were both high leaving many so miserable an index was conceived in their name. And crime, well, it was at least perceived to be rampant and televised for good measure.
Hence the chilling lyrics, “When people lock their doors and hide inside. Rumor has it it’s the end of Paradise.” That one line in particular stopped yours truly in her tracks upon recently hearing the song for the first time in ages. Those haunting words transported me back in time to a conversation I’d had with then-Dallas Federal Reserve President Richard Fisher, who I advised back then. News of riots in the streets of Athens were flooding the airwaves. As safely removed as we were from the anger, violence and flames, he said he worried we would witness the same in our own streets if things didn’t change.
Surely not. Not in our lifetimes.
Maybe it’s time to spend less time pondering public pensions, time to stop worrying. Life is short. But then, denying a dilemma because it’s ostensibly insurmountable is never wise. Ask any politician cum lobbyist.
The fact is public pensions are an intractable issue that is growing as a factor of time and worryingly, increasingly ignored. And these are the best of recent times for pensions, without question. This from Bloomberg: U.S. state and city pensions posted median gains of 4.1 percent in the first three months of this year, the sixth consecutive quarter of positive returns, the longest winning streak since 2014.
While this moment in time will alleviate some of the $2 trillion in underfunding, it cannot be enough to make up for lost time given that the depth of the hole was less than $300 billion in 2007. As is plain, a whole heck of a lot of damage was exacted in the short space of a decade. Obviously, there was blood in the Street during the crisis years. But that dark chapter was followed by a magnificent rally in risky assets.
The means by which pensions find themselves bound by Gordian’s knot is simple: time.
For today’s older folks, the miracle of compounding interest is a simple and beautiful phenomenon. In addition to the income you gather on the principal you’ve invested, time sweetens the pot if you leave your earnings be. Your interest also earns interest, more is more. The growth is a sight to behold. That is, if your age begins with the number ‘6.’
Central bankers, in their infinite wisdom, have consciously robbed generations plural of such an ideal. Zero on zero gets you zero. No beauty there.
Unluckily, pensions have been allowed to exist in a parallel universe where zero interest rates don’t exist. Why discount future liabilities by zero, or even insanely low rates, just because the powers that be slam rates to the floor? That level of realism invites nasty side effects, as in an immediate tripling of pensions’ underfunding. Could any state or municipality shoulder such a heavy burden? (Answer: few to none.)
Instead, pension fund managers have traveled from one parallel universe to the next, to that of amplified assumed rates of returns to compensate for what reality simply cannot provide.
Think of it as the opposite of compounding interest. The insidious interplay between fancifully assumed discount rates and the unicorn returns we pretend managers can conjure on pension assets is where the word ‘damage’ comes into play.
In the same way compounding interest escalates the growth of your original investment, double denial in pensions renders the damage inflicted permanent.
While that four percent racked up in the first quarter sounds great, ask yourself this: can it compensate for the average annual return of 1.5 percent chocked up in the fiscal year ended June 30, 2016? Well sure, except for one glaring detail – the rate of return assumed was north of seven percent, again, on average.
It is THAT gap, repeated year in and year out, that cannot and will not be made up as a factor of time. Returns have been too low for too long, as have interest rates, to rectify what ails pensions. To compensate, as has been more widely reported by the media, to its credit, pensions have been making investments in illiquid, expensive private equity funds. We’re talking $350 billion since 2007.
To be clear, a pension fund manager is fiduciarily responsible to ensure that adequate funds are on hand to meet the obligations promised to beneficiaries, that assets are on hand to satisfy future liabilities. Period.
Why on earth, mandated by that seemingly simple tenet, would any pension manager in their right mind, or with the best interests of their entrusted pensioners at heart, be investing in a distressed real estate or illiquid credit fund? And at this juncture in the cycle?
Before the arguments begin – that we’re at the precipice of some new paradigm, that tax cuts will reignite growth, that stocks are dirt cheap when adjusted for inflation, can we just agree on one thing? Can we answer one question please: Do recessions occur, eventually?
If you can acknowledge that there is cyclicality in the business cycle, there are deeper issues to discuss.
Consider that every (remaining) California household is on the hook for $93,000 to cover the state’s public pensions, at least as of the end of 2015 according to Stanford University. That gap will never be rectified, at least on planet earth, not without eviscerating what’s left of the state’s middle class. Sorry to rain on the Golden State, but good luck. Middle-income-earning, tax-paying Californians will continue to do what they’ve been doing, along with their cohorts in Cook County, Illinois. They will continue to vote with their feet and relocate to states with better tax climes. And why shouldn’t they?
Economists like to gloat about inflation and unemployment hovering near record lows. But the truth is, a vast majority of Americans today are subject to a different kind of misery index, one that could be a kissing cousin to that of the late 1970s. Call it the bondage index. Buying a new starter home and renting your first apartment are so prohibitively expensive the homeownership rate among Millennials is the lowest on record for their historic age group. And while the unemployment rate is near record lows, it’s nothing to write home about, at least for the millions upon millions who’ve been forced to work part-time or take on two jobs just to make ends meet.
In other words, the statistics may not lie but they sure as hell don’t tell the whole truth. As one astute Twitter follower commented following fresh data on rising car repossessions, “Between losing their transportation to their job and unaffordable housing, expect the bottom 20 percent who have lost out to get desperate.” Economic bondage will do that.
Maybe you can help connect the dots. We’re in the third longest economic expansion in postwar history. Stocks have enjoyed their second longest bull run ever. Public pensions are loaded up to their eyeballs in risky assets because there are no alternatives aside from the alternative investments they’ve piled into that will give them no cover in a downturn. How exactly does this story have a happy ending, for pensioners and 401k-holding taxpayers alike?
Some arbiter from some corner will have to rise up to resolve this dilemma. The judiciary will certainly play a lead role in setting precedents. Strong leaders will also have to make tough calls knowing full well that unions will stage a rebellion. It won’t be easy to convert future public employees to the same retirement reality the rest of us rely on.
But what other choice is there? Cutting public services to such an extent that taxpayers take to the streets? Or worse, that we lock our doors and hide inside?
Teddy Roosevelt once said that, “People don’t care what you know until they know that you care.” We must ask ourselves how the barely-contained anger manifests itself when the masses wake to the knowledge that the most knowledgeable cared the least.
Article by Danielle DiMartino Booth, author of Fed Up: An Insider’s Take on the Why the Federal Reserve is Bad for America