What's the scariest investing story of 2008 so far?
It's not news that the median price of a new house is down 17% from its 2007 high --- and still falling.
Or that Miami has a 37-month supply of unsold condos, with 19,000 more new units set to hit the market this year.
Or even that losses at banks and investment banks in the debt-market meltdown could hit $400 billion.
Here's my nominee:
The Pension Benefit Guaranty Corp., the government agency that protects the pensions of 44 million workers in case their employers can't (or won't) pay promised benefits, has announced that to avoid going bust it will double the percentage of its portfolio -- to 45% -- that it puts into stocks. An additional 10% will go into alternative investments, including hedge funds.
In other words, facing a $14 billion deficit and even larger projected shortfalls, the Pension Benefit Guaranty Corp., or PBGC, decided not to save (by raising premiums) or to live within its means (by cutting benefits) but to gamble in the financial markets by taking on more risk. The PBGC was so proud of its new strategy that it announced it on Presidents Day, when the U.S. financial markets were closed and almost no one was paying attention.
So why is this so scary?
Because as a result of 10 years of booms and busts -- the Asian currency crisis, the Long Term Capital Management hedge fund disaster, the tech stock bear market of 2000-02, the housing smash-up, the debt market debacle -- I've increasingly come to believe that those of us who play by the rules (work hard, live within our paychecks, save) are chumps. The way to get ahead is to gamble big and then, if you lose, find someone to cover your losses.
Anger and fearI've been hearing the same thing in e-mails from some of you. There's sympathy for families that were defrauded in the housing boom and now face foreclosure. There's a willingness to fix the system so that buyers with a mortgage they can't afford don't lose everything. But there's also a deep anger from those of you who played by the rules and didn't buy more house than your paychecks would cover and are now paying the price in falling home values, a slowing economy, jobs lost and a sinking stock market.
Some of you are afraid -- for good reason -- that you'll be picking up the tab not just for honest mistakes but for greed and fraud as well.
Some of you have written to me saying that playing by the rules only makes you a loser. I've tried to argue you out of that conclusion despite my own doubts.
And now I've read a story about the PBGC's decision to roll the dice. And it scares me because it says that even the folks who are in charge of the game, the ones who should be models of prudence, are turning into gamblers willing to throw up their hands and say: "Roll seven. Come eleven. Baby needs a new beach house with an ocean view."
Here's the problem the pension agency faced and the fix it came up with:
How it's supposed to workThis agency, set up by Congress in 1974, is supposed to fund the pensions of workers when their employers go bust or get bought by someone who shuts down the plan. For a worker retiring at 65, payments from the PBGC currently max out at $51,750 for a pension plan set up by a single employer. If the plan promises benefits above that and goes belly up, sorry, but you're out of luck.
When Congress set up the PBGC, it didn't provide any taxpayer money to pay out these benefits. Instead, payouts are funded by premiums paid by companies that sponsor pension plans -- plus investment returns on the money the PBGC holds, pending future payouts, and any money it recovers from plans that go bust. In 2008, the premium is $9 per worker covered by a multicompany plan; for single-employer plans, it's $33 per worker plus $9 for each $1,000 of unfunded vested benefits.
Unfortunately, the premiums don't cover what the fund has to pay out in most years, and the odds are that the deficit will grow. The agency estimated that for fiscal 2006, the pension plans it covered were a total of $500 billion short. If any of these underfunded plans went bust, the assets that it turned over to the PBGC wouldn't cover the guaranteed payouts of retired workers, which would run the agency's deficit higher.
Several options for a solutionThe pension agency could have decided to fix its deficit problem by:
- Raising premiums, which would have required a politically unpopular vote by Congress.
- Lowering payouts, which would have required a politically unpopular vote by Congress.
- Tightening rules, so companies would stop underfunding their pensions, which would have required a politically unpopular vote by Congress.
- Purchasing a lottery ticket and announcing the problem was fixed.
Guess which solution the agency picked?
Here's how the PBGC described its solution: If the agency kept its current portfolio mix of 72% fixed income and 28% stocks, the odds that it would be solvent in 10 years were just 20%. If the PBGC put 45% of its portfolio into stocks and 10% into alternative investments such as hedge funds, and reduced its fixed-income allocation to 45%, the odds of being solvent in 10 years would go up to 60%.
That new asset mix would have worked out just fine for the PBGC in 2007, when its equity investments returned 16.5% and its fixed-income investments returned just 3.4%. On average, from December 1925 to the present, stocks as measured by the Standard & Poor's 500 Index ($INX) have returned better than 10% annually, while long-term government bonds returned just over 5%. So in changing its asset mix, the PBGC would seem to have history on its side.