Tuesday, August 07, 2007

The Dangers of Retirement Hedge Funds

This is what an editorial in the New York Times entitled Pensions and the Mortgage Mess had to say about risky mortgages being added to pension funds today:

Even as the plunge continues in investments tied to dicey mortgages, government regulators remain skeptical of the need for new rules to cover these newfangled derivative products or the hedge funds that tend to buy them.

The Federal Reserve chairman, Ben Bernanke, rightly argues that these are important instruments, making credit more available and allowing risk to be spread broadly. But as the casualties mount to more than just a few buckled hedge funds, it is important to address the downsides.

There is a real danger that the casualties to come will include a more vulnerable set of investors: the pension plans of working Americans. Mr. Bernanke recently told Congress, “In most cases, I think that pension funds should probably not, you know, go heavily into these types of instruments.”

But faced with growing numbers of retirees, some pensions — including those for police and firefighters in Ohio and Dallas — have been unable to resist making these risky investments in an attempt to increase their returns. Public and private pension funds have also plowed tens of billions into hedge funds, which have been piling into mortgage-related securities.

Many pension plans lack the analytical skills needed to evaluate these investments, relying on outside advisers and rating agencies. But the stellar triple-A rating assigned to many of these bonds proved to be misleading — with the agencies now rushing to downgrade them.

So far there have been no reports of pension plans in trouble because of the mess in the mortgage market, but we fear that it might only be a matter of time. The fact that pension plans are insured — private plans by the Pension Benefits Guaranty Corporation, a federal agency; state and municipal plans by taxpayers — makes the case for enhanced regulation even stronger.

Protecting pensioners from bad investments will not be easy. A good place to start would be to make rating agencies more accountable, perhaps by asking regulators to monitor their quality. Pension law should also be changed to ensure that the premium that private pensions pay into the P.B.G.C. takes into account the risk of their investments.

What is crucial is to ensure that pension managers perform adequate due diligence to understand what it is that they are buying. Regulators must make sure of that.

Given what we have seen happen to the working class' retirement funds through corporate bankruptcy and schemes like this, I am not yet convinced that expanding Social Security into a full pension plan for the elderly isn't a better, more secure way to go. Can we really trust private entities with pension funds anymore? In any case, even if my idea is not adopted, premiums paid the the PBGC reflecting the risk of pensions failing due to riskiness of their investment portfolio would be a good start.

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