(James Saft is a Reuters columnist. The opinions expressed are
By James Saft
May 1 Atlanta Public Schools is considering
selling up to $540 million of bonds to make a leveraged bet on
the stock market, an idea so bad it almost goes beyond the
meaning of 'idea' much less 'bad'.
But like so many bad ideas, pension obligation bonds are a
hard one to kill, probably because they are profitable for
service providers and allow those in responsibility to shift
risks and costs away from themselves.
Struggling with a massive deficit - it holds only 16 cents
of assets for each dollar of benefits promised and is paying out
money nearly as fast as it is coming in - the Atlanta Public
Schools' pension fund is mulling a 20-year bond issue of as much
as $540 million.
It is hoping to plunk the money down on investments and earn
more than it will pay out in interest, using the difference to
keep a lid on what otherwise would be painful rises in local
taxes or a diversion of existing revenue away from other uses.
The Atlanta Journal Constitution ran an excellent piece
which is worth reading in full for the complete rundown. (here)
The school district figures it can make about 7.5 percent
annually on its investments, as compared to a 4.5 percent annual
rate of interest on the bond.
Though not new - many other pension funds around the country
have issued similar bonds with very mixed results - this is just
a spectacularly wrong-headed approach towards investment, and
towards meeting the obligations of the fund.
While the 4.5 percent interest rate is probably broadly
correct, though it is unclear if that includes amortization of
the likely considerable upfront fees the fund will be charged
for selling the bond, that 7.5 percent return, without which the
arbitrage fails, is far more speculative.
The fund may not be able to reach that benchmark for a host
of reasons. Global markets might create lower returns in the
coming two decades due to demographics or simply because of an
inopportune entry point. Remember that after the blood bath at
the end of the last decade, many investors were looking at a
decade-long loss in their equity portfolios. Should the Atlanta
fund suffer such a loss over the coming decade, the leveraged
nature of the bet combined with the already very poor funding
position would put it, its pensioners and the taxpayers of
Atlanta in an extremely difficult position.
RISK SHIFTING, A SPORT AND A PASTIME
That's not to mention the possibility that the fund simply
chooses its managers badly and suffers a loss or poor
performance despite market gains. And while we won't know for
sure who will manage the money or what strategy they will
follow, I am betting that a pension fund which thinks it is a
good idea to borrow money to speculate on markets won't be going
the low-cost, passive route.
Now, you could defend this move by comparing it to
retirement savers, many of whom hold a sizable mortgage while
also investing in the stock market for their retirements. That
argument won't float. Owning a house is a perfect hedge against
needing a place to live, first off. More importantly, the person
taking the risk of holding a mortgage and funding a 401(k) is
the same person on the hook for the results.
That's simply not true when it comes to school boards,
municipalities or states and pension funds.
What is really going on here is a convenient shifting of
risk from those currently responsible for the pension fund and
Atlanta's schools to future and current retirees and Atlanta
residents and schoolchildren.
This is a generational risk shift. Voters who approve such a
plan avoid taxes or worse services in the near future but create
a rump risk of much higher taxes further down the road if the
gamble doesn't work.
Not only will many of today's voters not be around to pick
up the tab when it comes due, the experience of Detroit shows
that tomorrow's voters may choose not to be around either if the
bill becomes too large. Why would someone want to pay high
property taxes in 2033 to make good for a bad pension gambit in
2014? Just move to the suburbs.
This is also unfair to pensioners, for whom it creates a
larger risk that, if things go bad, there won't be political
will to pay their earned benefits in the future.
In fact, there is only one group for whom this is a definite
home run: financial intermediaries, who will earn fees by
selling the bonds and further fees by investing the money once
it is raised.
Leverage has its place, but not in public pensions.
(At the time of publication James Saft did not own any direct
investments in securities mentioned in this article. He may be
an owner indirectly as an investor in a fund. You can email him
at firstname.lastname@example.org and find more columns at blogs.reuters.com/james-saft)
(Editing by James Dalgleish)