Politicians love to give government employees lavish pay and pension packages. It’s so easy to do. With a strike of a pen he or she can keep a key political ally happy. If the government workers are satiated life is usually easier for the governor.
The problem is that eventually the money runs out. In the case of pensions a certain rate of return is necessary for the pension to remain solvent. In the short term shortfalls might be covered by tax revenue or debt, but if a pension needs an 8% return and it has gotten 3% over a few years that pension is in trouble.
This has indeed been the situation over the past few years, exacerbated by the pig in the demographic python called the Baby Boomers. A whole bunch of people are just starting to retire, and they expect to live off of their pensions. Something’s got to give.
One way to potentially increase returns is by taking on more risk. As the attached article reports, many pension managers are using more volatile financial products than was formerly typical to reach their goals these days.
In addition to being riskier these products also tend to be more expensive, fee heavy.
Many retirees who manage their own portfolios are forced to take on more risk too thanks to the repression of interest rates by the Federal Reserve. Because low risk assets return almost nothing, in inflation adjusted returns actually produce a negative return, grandma must venture deeper into the stock market in search what she needs to keep her nest egg alive. The pension managers are doing the same thing only on a much grander scale.
This is why for all the “1%” rhetoric the fate of many progressives lay right in the hands of the big Wall Street banks. If Wall Street fails state pensions fail. And this is one of the reasons the Fed will continue to juice markets.
(From The American Interest)
The cycle of dependence on Wall Street usually follows a pattern. Public employee union leaders demand generous benefits as the price of their political support; politicians promise things like higher future pay and early retirement. Wary of public backlash, however, these officials don’t advocate cutting services or raising taxes to cover the shiny new pay packages they have established. The discrepancy between benefits promised and funds available becomes unbridgeable. Desperate to keep from falling too far behind, pension funds turn to the risky side of Wall Street, which gets rich off the panic. All too often, the Wall Street solution to blue model imperatives leaves taxpayers and pensioners stranded.