The Next Financial Catastrophe
Jon Entine, in reason, predicts that the pension funds -- funds worth trillions of dollars -- will be the next to implode...and as soon as 2009, thanks to a sinking stock market and investment strategies influenced by political considerations:
Traditionally, public investments and union-based corporate pension funds were managed according to strict fiduciary principles designed to protect workers and taxpayers. For the most part they invested in safe government securities, such as bonds or U.S. Treasury bills. Professional managers oversaw the funds with little political interference.But during the last 30 years, state pension funds began playing the market, putting their money into riskier and riskier securities--first stocks, corporate bonds, and foreign investments, then real estate, private equity firms, and hedge funds. Concurrently, baby boomers whose politics were forged in the 1960s and '70s began using those pension funds to advance their social visions. Investments designed for the long-term welfare of retirees began to evolve into a political hammer. Some good occasionally came from the effort, as when companies were pushed to become more accountable in their practices. But advocacy groups often used their clout to direct money into pet social projects with dubious fiduciary prospects. Sometimes the money went to the very companies and financial instruments that, in the wake of the market meltdown, are now widely derided.
Many union funds and larger state pension plans screen stocks and investment opportunities based on what are known as "socially responsible investing," or SRI, principles. Instead of focusing solely on maximizing value, fund managers have used the economic clout of concentrated stock holdings to make a statement by divesting from companies that don't make it through certain "sin screens." These included companies involved with weapons, nuclear energy, tobacco, alcohol, natural resources, and genetic modifications on agriculture, many of which did well over the past decade. Stocks of public companies deemed to have poor records on labor, environmental issues, women's rights, and gay rights are also frequently screened out, as are corporations that do business with regimes that activists consider unsavory. In some cases, investments have been withheld altogether from some of the markets expected to best weather the current financial storm, including China and India, because of perceived transgressions.
Socially responsible investing now claims a market of more than $2 trillion, according to the Social Investment Forum, the trade group for social investors. There are dozens of mutual funds and investment advisory companies that incorporate ideological screens. Most of them are liberal, although there are now a few conservative funds and some based on religious principles, such as Islamic law. Activist treasurers and pension fund managers in numerous states and municipalities, most notably in California, New York, and Connecticut, have incorporated social screens into their investment strategies.
Many of these funds prospered in the 1990s, when the basic material stocks that they frowned upon swooned, while the favored sectors--mostly technology and financial stocks, which were considered "clean investments"--did great. But the technology and communications bust of 2000-02 knocked out one of SRI's pillars, and now the crash in financial stocks has destroyed the other. Despite much hype to the contrary, socially responsible stocks, as measured by major broad-based SRI stock funds, have significantly underperformed the market this decade, and some of the most aggressive pension funds that use "responsible" screens--such as the California Public Employees' Retirement System--have taken some of the largest hits.
The only 2 criteria for investments should be risk and return. If you invest money based on other criteria then don't be surprised when the results are less than stellar ...
Charles at March 2, 2009 6:10 AM
It's silly to claim pensions invested in the financial sector in the 2000s because that sector was "socially responsible."
If anything, it's because pension funds, like so many other funds, were led by managers that bought into the real estate bubble and by managers who oversaw more and more pension money in what was a) a rising market, and b) a climate in which funds were being raided during buyouts.
Is Entine saying that if there had been no social investing movement, that the pension funds would today still be investing only in T Bills, and would not have invested in all those safe and terrific credit default swaps and derivatives and mortgages?
Doubtful.
jerry at March 2, 2009 6:28 AM
The next catastrophe, presuming our robotic president doesn't decide to blow another trillion dollars that we don't have, is Alt-A.
Crid [cridcridatgmail] at March 2, 2009 7:59 AM
Maybe it's confirmation bias, but this reinforces my opinion of the lack of viability of large organizations and central planning in general. When a small number of people make decisions that affect a large number of people, the impact of good and bad decisions are magnified. The more layers in an organization, the more removed the decision-makers are from the consequences of their decisions, leading to fiscal irresponsibility like inadequate pension funding (which was a big problem in the private sector a few years ago, though I'm not sure what the current state is.)
I don't know for a fact that distributing pension investment decisions to the people benefiting from those pensions would have avoided these particular bad investments, but at least then the mistakes would be made by the people who will be directly affected, and people who are close to or past retirement would have had the option of moving their retirement money into safer investments.
The best long-term solution is for the economy to be made up of a large number of small organizations rather than a small number of large organizations. I haven't been able to figure out, though, how a large number of small organizations can do what, say, GM does. Some tasks just require a lot of people. Maybe inefficiency is something we have to put up with.
Pseudonym at March 2, 2009 8:10 AM
The song lyric:
I met a girl who sang the blues,
And I asked her for some happy news,
but she just smiled and turned away.
has been jangling around my brain for months and months now.
I remember the billionaire Wilbur Ross being interviewed last summer, and he was saying if the S&P Financial Spiders dropped below $20, they would be the "screaming buy of a lifetime." He's one of those guys who seems to really get the big picture stuff. Today the XLF is $7.15.
Eric at March 2, 2009 8:58 AM
Hey Eric, is that an investment tip?
Crid [cridcridatgmail] at March 2, 2009 9:08 AM
Not from me it isn't. My point is this guy, who knows a hell of a lot more than 99.99% of the talking heads out there, got it so wrong. So did Buffett.
I've been bearish for over a year, almost two. We completely pulled out of the market, except our retirement funds, in 2007. I won't be suprised to see capitulation around Dow 5,500-5,000.
Eric at March 2, 2009 9:14 AM
Amy Alkon
https://www.advicegoddess.com/archives/2009/03/the-next-financ.html#comment-1636643">comment from EricSo glad to hear you got out, Eric.
Amy Alkon
at March 2, 2009 9:24 AM
Out of the frying pan into the fire! I am forclosing on 3 separate households as we speak. Anyone want to buy land in Idaho?
Eric at March 2, 2009 9:27 AM
I'm still in, but it wasn't much of a retirement plan to begin with. As noted in earlier comments, buying no-load index funds seemed like a comically conservative approach: Turns out I was blowing money like a drunken sailor in port.
Crid [cridcridatgmail] at March 2, 2009 9:38 AM
No kidding Crid. I just hope that in my old age I don't have to work at a job that involves wearing a smock.
Pirate Jo at March 2, 2009 9:59 AM
Fries with that?
Crid [cridcridatgmail] at March 2, 2009 10:20 AM
It'll be just like high school!
Pirate Jo at March 2, 2009 10:27 AM
But without the optimism. Remember when drugs were for fulfillment, and not blood pressure?
Crid [cridcridatgmail] at March 2, 2009 10:33 AM
I worked my way through college at the grocery stores. I can bag groceries like a son-of-a-bitch.
Eric at March 2, 2009 11:40 AM
Yeah, when they have me back in fast food, you can finally get your drive-through order right! I don't forget the napkins either.
Pirate Jo at March 2, 2009 11:43 AM
Ah, the joys of sloth.
See, I was too lazy to research mutual funds and whatnot for the newer of my SEP-IRA contributions, so the money I put in for the past few years just sat in cash.
The earlier stuff I put in funds? Lost 50% in the last 12 months. It's worth less now than when I bought it, and that's including years worth of dividend re-investment.
The cash? Still worth cash. Unless there's massive inflation (who am I kidding, inflation is a foregone conclusion), I've still got something.
Granted, it's enough to retire about 6 days before I die, but still.
brian at March 2, 2009 12:07 PM
So, AIG is back in line for a handout and the DOW dropped 300 points today. What erodes my confidence isn't the failure of AIG but the fact that my tax dollars are being used to bail it out.
Pirate Jo at March 2, 2009 2:53 PM
The pension collapse is looming, that is true, but I think the next disaster will come from Europe.
The economies of Eastern Europe are teetering on the brink, and if they go down, the loan defaults from gov't., corps., and individuals in EE will collapse the banking sectors in Austria and Germany. They are heavily invested in EE.
The defaults out of South America will hit the banks of Spain hard... and they are already weak from Spain's housing market bubble. Spain itself could default.
I don't know if the Euro can handle these problems... and if Europe loses faith in the Euro...
stevieray at March 2, 2009 10:36 PM
Fuck that shit! If I work at anything in my old age, it'll be crime. Dangle that carrot for 39 years, yank it away and kick me in the teeth, this old donkey isn't going to take it lying down, she's gonna kick the shit out of the takers!
If I go to jail, even Sheriff Asshole's out in Arizona, good fucking luck getting me to work. Good fucking luck when I worked like a horse for decades only to get screwed through no fault of my own.
Go ahead. I already know what you all are going to say... But the truth of the matter is that the rich got so fucking full of themselves is that they forgot they actually fucking need the poor. Need to give us some incentive to work that damned drivethrough (and by that I meean producing the goods and services that the rich sell and wouldn't have to sell without the working poor) instead of holding it up!
Where they went wrong is not only welfare (it plays its role) but corporate welfare and the haves hoarding. Maybe, just maybe, the young thugs have a fucking point when, having no other resources, they say drugs pay off better than McDonald's. How many would feel that way if McDonald's (who can well afford it without charging like a French restaurant) paid better than minimum wage? Narrow that gap between salary and crime, and the risk of crime does not become worth it.
T's Grammy at March 4, 2009 10:57 AM
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