Why Pension Funds May Be The Next To Collapse 2008 brought us the collapse of the housing market, the implosion of the stock market and the near collapse of the auto industry. We examine why some think pension funds will be the next domino to fall.
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Why Pension Funds May Be The Next To Collapse

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Why Pension Funds May Be The Next To Collapse

Why Pension Funds May Be The Next To Collapse

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ALEX COHEN, host:

From the studios of NPR West, this is Day to Day. I'm Alex Cohen. Next week, hundreds of thousands of Americans will descend on Washington, D.C., for Barack Obama's inauguration. Among those are 20 students from an intercity school in Atlanta. They are the chorus from the Ron Clark Academy, and they will sing at several events, performing a song called "Dear Obama."

(Soundbite of song "Dear Obama")

THE RON CLARK ACADEMY CHOIR: (Singing) Dear Obama, hear us sing. We're ready for the change that you will bring. Gonna shine the light for the world to see To spread peace, hope and democracy. The time is now...

COHEN: The voices of students from Ron Clark Academy in Atlanta. Later on in the program, we'll hear what it takes to move a president in and out of the White House. Here is a preview: just six hours and two elevators. First, though, more economic news and - little surprise - it's not good. About 27 million Americans are covered by public and union-based retirement plans, but funding for many pension funds is running out. Jon Entine wrote about this in the latest issue of Reason Magazine. I asked him how deep these pension plans are in the hole.

Mr. JON ENTINE (Contributor, Reason Magazine; Adjunct Fellow, American Enterprise Institute): Well, this is a figure that's slippery because the markets are melting, literally, by the day. When I wrote the article just a few months ago, through the end of October, it was in the $200 billion range. Now, we're talking upwards of $400 billion, and the markets are showing no sign of stabilizing, which is really going to cut even more into the solvency of many of these pension funds.

COHEN: And can you explain how the financial crisis created this situation for pension plans?

Mr. ENTINE: Well, we're really talking here about defined benefit plans, where pension funds are committed to paying a certain preset set of benefits to their employees, regardless of what the economic situation is in the pension fund themselves. And the reality of it is, is that these pension funds have faced a liquidity crisis and a financial crisis of their own. As the stock market has gone down, they have become very vulnerable. Suddenly, there's less money to pay out these defined contributions. And companies have to fork up extra money to cover this deficit, and if you're a public pension fund - state and union pension funds - governments have to fork over that kind of money. And it's really putting a great stress on the system that's actually, getting worse day by day.

COHEN: So, how are companies going to deal with this?

Mr. ENTINE: Well, the companies deal with it by, literally, having to suspend dividends, having to cut costs more, having to lay off employees - really, a feedback loop to the downward spiral that we have. So, really, we've set the stage for kind of another run on these companies and their profit margins. They're going to be squeezed even further in the months ahead as they have to fulfill their mandated, legally mandated, pension obligations.

COHEN: John, I'm sure listeners are hearing this and thinking about their own plans with their own employers. Are there any standards that these companies have to meet if they promise a certain amount to employees after they retire?

Mr. ENTINE: Oh, there are government standards. Companies do have obligations, which is essentially what's put them in a bind. You know, you have the company pension plans - that's obviously a major issue - but we also have the government pension plans, the union-funded pension plans through states, teachers, programs, firefighters, police. They are also facing huge problems in the months ahead.

COHEN: You write that pension funds used to be invested conservatively, but that's changed. What's happened?

Mr. ENTINE: Well, I think that there's a pressure on states and localities that really started to appear in the '90s and after the recession in 2000, 2001, where they felt they had to keep up with the stock market. There was large demand for increase in public services and pension funds, particularly government pension funds, really began to throw out the traditional-risk, fiduciary-based metrics that had guided their investment philosophies for many, many years. When workers demand more and more benefits, when baby boomers retire and add to the pension rolls, this puts pressure and prompts many pension-fund supervisors to take higher and higher risks. And they started gambling in the same way that the casino economy experience gambling in all aspects of the stock market, going into private equity, hedge funds, risky financial stocks. And when the market imploded, pension funds fell along with all other investments.

COHEN: A lot of companies in recent years have also decided to invest funds in companies that are socially responsible. How has that affected the situation here?

Mr. ENTINE: Well, let me say that socially responsible investing is an appropriate philosophy for pension funds to engage in, in the sense that it's another risk metric. And one of the key factors for fiduciary responsibility is to assess risk. So to the degree that some kind of political or social or environmental issue may affect the returns on holdings in a pension fund, they have to address this. So to that degree, social-responsible investing is a good thing. The problem was we have a kind of fashionable litmus-test social investing that emerged out of the 1980s and 1990s that focused on ideological vanity issues, kind of using subjective standards to decide what country is appropriate to invest in, whether defense stocks are appropriate to invest in, and yet our country clearly needs a defense establishment. And when you start using those kinds of politically inspired screens, you really start injecting politics rather than standard risk measurements. And that's where we've gotten into problems in the past six or seven years.

COHEN: Some of the big pension funds, such as CalPERS here in California, have seen that they're in big trouble. What are they demanding be done to try to avoid more problems in the future?

Mr. ENTINE: Well, first of all, in the short run, they're having to demand that states and localities fork over more money to cover the shortfall, which is pressing local communities very, very dramatically. But they've also began abandoning some of their screens because they recognize that some of them really were too narrowly construed. And I think that there's a return to a much more sound, fiduciary-focused sense of responsibility. The California pension-fund system has, as of today, lost close to 30 to 35 percent of its value, which for a pension fund - which is supposed to be conservatively invested - that's close to tracking the S&P 500, which is absolutely horrific and, I think, really a travesty for the taxpayers and pension holders of California.

COHEN: Writer Jon Entine wrote about the troubles facing the nation's pension plans for Reason Magazine. Jon, thank you.

Mr. ENTINE: Thank you.

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