Friday, November 17, 2017

Another cardinal sin: the North Carolina Treasurer shuts down the pension’s investment programs

Another cardinal sin: the North Carolina Treasurer shuts down the pension’s investment programs

For the past few months I haven’t paid much heed to the investment programs of the North Carolina Retirement System.  Today I went back to take a look at the pension’s returns after the November 2017 meeting of the Investment Advisory Committee.  Rising equity markets have produced positive returns for the pension.  Those returns don’t measure up to most public pension plans because the pension continues to utilize a more conservative asset allocation than its peers.  This is the result of the stewardship of Treasurers Boyles, Moore, and Cowell.  Unfortunately, the latest investment report shows that the current treasurer Dale Folwell is well on his way to damaging the investment programs of North Carolina’s pension plan.



First, the State Treasurer has failed to reverse the ill-advised market-timing tactic in which he sold $7.2 billion in equities in the first half of the year.  Since I last wrote on this subject, equities have risen another 5%, meaning that the Treasurer’s action has cost far more than the $250 million I’d originally estimated.    For those readers interested in the pitfalls of the Treasurer’s decision to sell equities and stockpile cash and bonds, you can find a series of posts I wrote in June.[1]   Treasurer Folwell’s goals were to reduce fees and remove poorly performing managers.  In the process the Treasurer committed the cardinal sin of investing by attempting to time the market. 

Second, the Treasurer has virtually shut down the State’s investment programs.  Since the beginning of the year, the pension has made no new commitments to any asset class other than a very recent $100 million commitment to a new internally managed index program.[2]  While I understand the need for the new treasurer to review the existing investment program, it’s been over a year since his election, and he has not approved one new investment in equity, private equity, real estate or fixed income. [3]  To put it succinctly, investment programs die when they stop investing.  If the Treasurer doesn’t reverse course soon, he’s going to permanently damage the investment program by losing investment opportunities, relationships, and staff.  While the pace of investing may ebb and flow, a seasoned institutional investor must remain active in the financial markets.
It’s hard for me to believe that a $96 billion pension plan couldn’t have benefitted from some type of new investment in the first eleven months of 2017.  In addition, it’s impossible that not one of the state’s existing managers had anything of value to offer the pension plan in 2017.  Finally, the investment staff, which has accumulated a great deal of knowledge and expertise over the years must be in the process of questioning whether it makes any sense to work for a program that doesn’t make investments.  In fact, the pension plan has already lost its Chief Investment Officer and director of real estate.   I suspect other positions are vacant as well, although there’s no way of telling from the publicly available documents.

As I’ve said previously, the Treasurer has some reasonable ideas about reform.  However, his actions in timing the market and shutting down the investment programs have done more damage in one year than his reforms can do good in a decade.



[1] See, “A case study on the weakness of the sole fiduciary model,” 7/19/17; “Lowering management fees is a laudable goal, but it has to be done prudently,” 7/18/17; “The danger of market timing: North Carolina’s Treasurer raises cash,” 7/17/17; and, “North Carolina’s pension cuts fees and hurts its prospects, ”7/14/17.

[2] The pension plan has been looking at managing some of its passive (or index) exposure for years.  Apparently all the pieces are finally in place to allow staff to begin to manage a small portion of these funds.  As I recall, this idea was first proposed under Treasurer Moore and put into legislation by Treasurer Cowell.  The idea is to save a few basis points in fees and give the staff greater hands on exposure to the market.  I’ve opposed this proposal because I believe there’s long-term risk involved in bringing index investments in-house.

Friday, October 20, 2017

It’s not just a tactic. It’s a disease

It’s not just a tactic.  It’s a disease

Whether it’s attacking gold star families, NFL players, Muslims, North Korea, Senate Republicans, Senate Democrats, Secretary Clinton, or the media, President  Trump isn’t just playing to his base.  He is exhibiting signs of a diseased mind.



Nearly every constituency in the country is scrambling to stop the Trump Administration from dismantling some policy that they support.   While progressives seem to have a longer list of items that are keeping them up at night, conservatives also have big concerns, especially in the areas of foreign policy, diplomacy, and defense.  The mad scramble to oppose the President on so many issues has prevented the vast majority of Americans and their elected representatives from focusing on the paramount problem with the President.   Mr. Trump is unfit to be President because he has serious mental health issues.  One issue should be at the top of the agenda, containing and then removing Donald Trump from the presidency. 

I’m not a psychiatrist, and the profession is inhibited from forming an opinion because of the Goldwater rule, which prohibits members of the profession from making a diagnosis without direct examination of a patient.  However, you do not a direct exam to find unequivocal evidence that the President is suffering from a serious defect of some kind even if you aren’t allowed to name it.   If the President’s disease were a physical ailment, we would not need a physician or an examination to determine that something is really wrong.

There are hundred of examples of the President’s behavior that are unequivocally abnormal, and make clear why Donald Trump should not be in a position to make unilateral decisions about the future of our country, especially the commitment of our military to hostile action or the use of nuclear weapons.

Some of you may believe that many of Mr. Trump’s most outrageous statements are simply an attempt by the President to confound his opponents and keep them off-guard.   This is the standard rationale used to explain the President’s statements about North Korea.   There’s one huge problem with this defense of the president’s behavior.  The president makes outrageous and untrue statements even when there’s nothing to gain, and he does it numerous times every day. 

In addition, he responds impulsively without the benefit of facts or advice.  He is incapable of self-reproach or reflection, and he is highly offended by even the smallest slight.  Moreover, the president meets even mild criticism with a disproportionate amount of vitriol and belittlement.   The only advisors that he seems to tolerate aren’t advisors at all.  Rather their role is to stroke the President’s fragile ego.


We’ve had many presidents with mental health issues, but President Trump’s disease represents a danger that threatens the existence of our country.  I’m done trying to figure out what the president believes, what policies he supports, and who he is prejudiced against.  He is a sick man, and he needs to be removed from power.  The founders gave us the means.  The people and their elected representatives need to get on with the job.

Monday, October 16, 2017

Part IV: Public pension plans in crisis: Share the risk or fail

Part IV: Public pension plans in crisis:  Share the risk or fail

When public pensions get to the point where they only have about 60¢ or less to cover $1.00 worth of obligations, the solutions are going to be painful for taxpayers and beneficiaries alike.  That’s the reality of a pension plan that has been allowed to fall so far short of its proper funding.  However, solutions exist that preserve a high proportion of the promises governments have made to their employees and retirees while creating incentives to keep the plans solvent once they’ve undergone reform.  States with deeply troubled plans should look to New Brunswick in Canada and to the Netherlands to find pension plans that have achieved sustainable reforms.  They might also reach out to Pro Bono Public Pensions.  Gordon Hamlin, whose story I told in the first post of this series, has developed a road map that might just put troubled pension plans on the road to recovery. Recently Gordon described the path forward on Kentucky Educational Television.[1]


As I discussed in part three of this series, solutions that put the entire burden on taxpayers or beneficiaries aren’t solutions.  In most instances, the deficit remains and/or government becomes incapable of funding its other vital obligations.

If deeply troubled pensions are to be saved and existing deficits addressed, three perspectives are going to have to change.

Beneficiaries have to agree to more realistic and sustainable pension benefits.  To be clear, I am saying that pensions will have to be somewhat less generous in the future. 

Taxpayers and their political representatives have to accept more realistic assumptions about investment returns and the liability being funded.  Again, so there’s no misunderstanding, taxpayers will be asked to make somewhat higher and more consistent contributions.

Shared risk has to become imbedded in public pension plans.  In other words, both taxpayers and beneficiaries have to bear responsibility when pension plans face challenges and enjoy rewards when they do well.  Without shared risk, pension plans will remain prone to insufficient funding and/or unrealistic benefits, which are the twin causes of instability.

When all the constituencies finally decide to solve the problem, public employees and retirees are going to have to accept some combination of longer working careers and more realistic retirement ages before drawing benefits.  In many public pension systems, beneficiaries can retire long before traditional retirement age.  Moreover, they have been living longer and therefore drawing substantially more benefits.

All too many public plans have automatic COLAs, which have continued to escalate the liability in deeply troubled pension plans.    COLAs do not have to disappear entirely, but they should be paid if and only if pension plans can afford the payments.

The traditional back-end loaded salary formula that drives retirement benefits will have to be modified to a formula that creates a more realistic average salary.   This is especially important for the highest paid positions in public pension systems.

The discount rate, which drives the assumed rate of return and discounts the pension’s liability, needs to be calculated at a more realistic level of 4.5% to 5.0%.  Most pension plans use discount rates that encourage excessive risk taking with the assets while grossly understating the liabilities.  This change will necessitate higher contributions by taxpayers, offset by the reforms already described in the previous paragraphs.

Politicians, beneficiaries, and trustees need to agree to a set of risk-sharing rules by which employer and employee contribution rates as well as benefits are adjusted depending on the financial condition of the pension plan.  If the plan’s funding falls below specified levels, contributions must increase and in certain cases benefits may have to be pared (with a guaranteed floor).  If benefits are reduced, priority should be given to restoring benefits before contributions are reduced.  Conversely if a plan performs well the same sorts of formulae should allow contributions to be reduced and/or COLAs to be paid.

To achieve a workable model all the stakeholders have to have a seat at the negotiating table.  Any one party trying to dictate a solution will probably be stymied by legislative intransigence or court challenges.  The stakeholders will have to jointly hire lawyers and actuaries to advise them.  If each side relies exclusively on its own experts it will be near impossible for the parties to agree on the financial impact of the reforms or the legal strategy for implementing those reforms.

The stakeholders will have to agree on a series of transition steps that bring about reforms over time.  Whether it’s raising the retirement age or changing the discount rate, change will have to be implemented in steps.   Public pension plans didn’t get in trouble in one or two years, and they won’t be restored to health quickly either.

If politicians, employees, retirees, and trustees can’t reach a sustainable solution for deeply troubled pension plans, states, municipalities, school districts, and all the other public entities with pension obligations will inflict major damage on their economies and the people they serve.   Shared risk or fail: those are the choices.




[1] https://www.ket.org/episode/KCWRS%20001307/

Thursday, October 12, 2017

Part III: Misconceptions and about the Pension Crisis and Solutions


Part III: Misconceptions and about the Pension Crisis and Solutions

Over the past several years all sorts of proposals have been made to solve the public pension crisis.  Many of these ideas have the benefit of being simple while creating the appearance of solving the problem.  Unfortunately they don’t address the pension deficit in any meaningful way.



Converting current and/or new public employees to a 401(K) solves the pension crisis. 

This is the preferred solution of free market conservatives and libertarians.  It’s galling that economically sophisticated advocates would propose a solution that is economic nonsense.  Shifting public employees to a 401(K) doesn’t do anything to reduce the unfunded liability.  The liability already exists and will require employer funding.   Government will still have to make contributions to retire the liability while simultaneously making matching payments to employee 401(K)s.   The 401(K) is simply a risk-shifting mechanism that puts the entire onus for funding retirement on the public employee.  Moreover, the 401(K) provides far less retirement security for the most vulnerable public employees, those toward the average and bottom end of the pay scale. 

Raising contributions to whatever level is required to fund the pension solves the crisis.

This is the preferred solution of retirees and many employee groups and understandably so.   The majority of retirees don’t have any realistic opportunities to increase their income.  While deeply troubled pension plans are unsustainable, retirees argue that the shortfall or insolvency is someone else’s problem to solve.  I know this is a hugely unpopular statement to make, but in the most seriously imperiled plans the retirees are going to lose part of their benefit.  Even worse, retirees will incur greater harm as time passes without a real solution.  In stark terms the pension crisis is merely a bankruptcy that has yet to be filed.  There’s still enough cash to pay benefits for a while, but these plans are economically bankrupt.  In fact the most poorly funded pension plans are so troubled that the taxes and fees that would be needed to dig out of the deficit would badly impair the ability of governments to provide other vital government services. 


Attract a lot more public employees, whose contributions to the pension plan would solve the problem.

Many public pension advocates have lamented that fewer and fewer current employees are “supporting” retirees.   They believe that public pension plans would be stable if there were many more contributions being made on behalf of young employees.  Most pension plans have aging populations, but even if they didn’t it wouldn’t solve the problem.  While more cash would come into the plan to pay current benefits, the long-term pension obligation would be growing to account for those additional employees, and that obligations would have to be funded as well as the existing liability.    It’s important to note here that public pensions aren’t “pay-as-you-go” plans in which each year’s contributions are used to pay benefits.

A maturing pension plan isn’t an existential problem if an aging plan is properly managed over time.  If contributions and investment practices are adjusted as the demographics change, a pension can remain stable.  As I discussed yesterday, those adjustments have not been made quickly enough for many plans.

The beneficiaries of reasonably funded plans have nothing to worry about.

While a decently funded plan doesn’t present any immediate worries to its beneficiaries, these plans are also prone to trouble in the long run.  Many of these plans are all too willing to maintain unreasonably optimistic investment assumptions, and they carry flawed actuarial assumptions that are hiding the true extent of the liability.  They are governed by boards who are too willing to enlarge benefits or retirement formulae without proper funding. Many pensions in states where politicians with very short time horizons aren’t inclined to fund long-term responsibilities.  In other words, the same sins committed in the worst-funded plans have yet to surface in better-funded plans.  Far-sighted politicians, trustees, employee associations, and retiree representatives would insist on immediate reforms.  However, it’s not going to happen.  There’s virtually no evidence that pensions will be reformed before they reach a state of crisis.


Tomorrow we will look at reforms that would address the pension crisis.