Thousands of Kentucky public school teachers
swarmed the state Capitol earlier this year, angry not about low salaries, but about their shrinking pensions. Among their concerns: the high portion of their money that has ended up in the hands of Wall Street in opaque, high-cost products that seem to benefit no one aside from the people who sold them. Rising pension costs helped to send teachers in Colorado
into the streets in protest a few weeks later. In the last year, pension woes have also prompted teachers in
Ohio and
Oklahoma to march. And police, firefighters, and other public employees in
Michigan have been staging protests since at least 2016 to preserve their public pensions, more than one-third of which is invested in “alternatives”: private equity, hedge funds, commodities, distressed debt, and other opaque Wall Street investment vehicles.
A “Wall Street coup” — that’s how pension expert Edward “Ted” Siedle describes it. Public pensions across the country now squander tens of billions of dollars each year on risky, often poor-performing alternative investments — money public pensions can ill afford to waste. For all the talk of insolvency,
$4 trillion now sits in the coffers of the country’s public pensions. It’s a giant pile of money of intense interest to Wall Street — one generally overseen by boards stocked with laypeople, often political appointees. “Time and again,” Siedle has written, “hucksters successfully pull the wool over these boards’ eyes.”
In 1974, in the wake of the spectacular collapse of the Studebaker car company and its pension plan, Congress passed a piece of landmark legislation, the Employee Retirement Income Security Act.
Under ERISA, companies are required to adequately fund their pensions and follow what was then called the “prudent man” rule, which barred those in charge from putting pension dollars into overly risky investments. The departments of Labor, Treasury, and Commerce were charged with overseeing the country’s pensions and a new body was created, called the Pension Benefit Guaranty Corporation, that would backstop pensions should a business default.
Except Congress left out public employees entirely — with a yawning loophole that granted an exemption to public pensions. ERISA expressly exempts public pensions operated by state and local governments — the plans that provide for the country’s teachers, firefighters, police officers, and librarians in their retirement. Forty-four years after the passage of ERISA, these public workers comprise the majority of active employees still contributing to pension plans. And they have been left largely unprotected.
Siedle calls it “the loophole that is swallowing America.”
The public pensions loophole helps explain why we read a lot more about underfunded state or municipal pensions teetering on the edge of default than we do dangerously underfunded pensions in the private sector. Thanks to ERISA, private pensions are better funded, and when they do face default, the federal benefit guaranty kicks in.
Because ERISA’s adequate funding requirement exempts governments, there are some half a dozen states with pension systems at the breaking point, including Illinois, where lawmakers are wrestling with unfunded pension liabilities of
$129 billion, and Kentucky, where the state’s unfunded public pension liabilities top
$27 billion.
That ERISA’s fiduciary oversight rule also exempts governments helps explain how Wall Street pulled off its coup, according to Siedle, a former Securities and Exchange Commission lawyer who for decades has been investigating public pensions. Instead of the strong protections imposed on the private sector by Congress, Siedle notes, “public pensions are regulated by a thin patchwork quilt of state and local laws,” and many don’t even submit to an annual audit. “No federal or state regulator, or law enforcement agency, is policing these plans for criminal activity,” according to Siedle. “No worries about the Department of Labor or FBI.”
Until the 21st century, public pensions
generally invested in a standard blend of stocks and bonds. The more daring or community-minded among them may have invested a small fraction of their holdings in real estate projects or other exotic investments, yet alternatives
averaged only 5 or 6 percent throughout the 1980s and 1990s. Yet as alternative investment structures grew in recent decades, and as pension funds sought desperately to make up for funding shortfalls, more and more of those trillions of dollars made their way to the country’s hedge funds and private equity managers. When, in 2017, the Pew Charitable Trusts
looked at 73 of the country’s largest public pensions, researchers found that a full 25 percent of the pension money was invested in these high-fee alternatives.
The irony is that pensions don’t need to be 100 percent funded to be sound, as employees don’t all retire at once. Rating agencies and government monitors typically consider 70 to 80 percent to be adequate. And the country’s public pensions are generally hitting that mark, averaging 76 percent funding as of 2015, according to
a survey by the National Conference on Public Employee Retirement Systems. “To suggest that there’s some nationwide crisis is simply not true,” says Bailey Childers, former director of the National Public Pension Coalition.
Yet public pensions continue to make desperate investments — and the competition for a piece of that action is so intense that it’s often involved outright fraud. It was in part a pension sting operation that helped take down Illinois Gov. Rod Blagojevich, who was back in the news earlier this year when President Donald Trump floated the idea of commuting the sentence of his former “Apprentice” star. In New York, Comptroller Alan Hevesi, who oversaw a $125 billion pension fund, confessed in court in 2010 that he had signed off on a $250 million pension investment in exchange for nearly $1 million in illegal gifts from a man named Elliott Broidy. Broidy, who ultimately pleaded guilty to a misdemeanor, is a major political donor with close ties to Trump; so close, in fact, that he resigned as deputy finance chair of the Republican National Committee this past April after it was revealed that Trump’s personal lawyer, Michael Cohen, arranged a $1.6 million payoff to a pregnant former Playboy model, allegedly on his behalf. Pension scandals have touched
the Carlyle Group, a well-feathered landing spot for retired public officials (including former President George H. W. Bush and former British Prime Minister John Major), and also some of the biggest names in money management on Wall Street. In July 2018 alone, the SEC sanctioned private equity firms and other investment advisers for violating its “pay-to-play” rules — in Texas, Wisconsin, Indiana, Illinois, Rhode Island, and Los Angeles.
A scandal in California didn’t involve any high-profile elected officials but was, if anything, even more outrageous. There, the CEO of the country’s largest public pension was brought down by a pay-to-play scheme involving a former trustee and billions of dollars in public funds. Fred Buenrostro ran the California Public Employees’ Retirement System from 2002 to 2008. Alfred J.R. Villalobos, a former CalPERS trustee who became a placement agent, allegedly paid for Buenrostro’s wedding, took him on a trip around the world, and paid him hundreds of thousands of dollars stuffed in
paper sacks and a shoebox. In exchange, prosecutors charged, Villalobos secured
more than $3 billion in CalPERS investments for his client, Apollo Global Management, a giant of the private equity world. Over a five-year period, Villalobos earned around $50 million for helping his private equity clients win deals with CalPERS; he pleaded not guilty but
took his own life before trial. Apollo’s punishment was the
additional $550 million it received from CalPERS in 2017.
Yet much of what Siedle called the “looting” of the country’s public pensions takes place through perfectly legal investments with exorbitantly high fees. As an example, he brings up Rhode Island, where he spent time in 2013 after one of the big public employees’ unions, AFSCME, hired him to investigate the state pension there. Rarely was the wealth transfer from workers to Wall Street as vivid. The new state treasurer, whose campaign had been bankrolled by several New York hedge fund managers, championed a plan that cut employee benefits by roughly 3 percent several years back — and then gave most of the money the system saved to a trio of hedge funds to which it had entrusted a big chunk of its investments. “It wasn’t an austerity program,” Siedle said. “It wasn’t reformed. It was simply about paying lower benefits so Wall Street could get paid.”
The High Price of Hedge Funds
Hedge funds and other more exotic investments come at a steep price. A pension fund seeking to own a diverse basket of technology stocks, say, or invest in promising, mid-sized European companies may hire a stockbroker to handle that aspect of its portfolio for around 0.5 percent annually, or $500,000 a year for every $100 million invested. By comparison, hedge funds and private equity charge fees that work out closer to 5 percent annually, according to Howard Pohl, an investment consultant who has been advising public pension managers for more than four decades. Yves Smith, the pen name of management consultant Susan Webber, puts that figure closer to
7 percent a year on private equity investments. That’s $5 million to $7 million each year on every $100 million a pension invests with a firm. The deal has worked out well for some of Wall Street’s best-known billionaires, including Stephen Schwarzman, CEO of the Blackstone Group, who pocketed
$787 millionlast year; Henry Kravis and George Roberts, the co-founders of Kohlberg Kravis Roberts, who took home a combined
$343 million in 2017; and Steve Cohen, the disgraced hedge fund king worth an estimated
$13 billion. All of them included public pension funds among their major clients.
The pensions haven’t fared nearly as well. The 2017 Pew study found that those funds that had recently and rapidly invested in alternatives reported the weakest 10-year returns. A
2018 report by the conservative Maryland Public Policy Institute put a price tag on those mediocre results. The group compared the actual performance of the $49 billion Maryland State Retirement and Pension System against a model with a straightforward “60-40” approach, in which 60 percent of a portfolio is invested in stocks and 40 percent in bonds. Despite the hundreds of millions of dollars in additional fees the pension system had paid to private equity firms and hedge funds, it would have earned an additional $5 billion over the prior 10 years had it adopted the more judicious 60-40 strategy. A
2015 studycommissioned by the then-$15 billion Kentucky Retirement System found that overexposure to hedge funds contributed to more than $1 billion in lost returns over five years when compared to the returns earned by its more cautious peers. A
study that same year by the liberal Roosevelt Institute and American Federation of Teachers found that poor returns on hedge fund investments had cost 11 of the country’s larger statewide public pensions $8 billion in lost revenue over the previous decade because most of the profits were eaten up by the steep fees hedge funds charge their investors.
“I could never figure out why somebody working at a hedge fund is worth 10 times more than the guy at Fidelity,” Pohl said.
Citizens United, the landmark Supreme Court decision that ushered in a boom in political dark money, also accelerated the siphoning off of billions of pension dollars into inappropriate investments. “Since Citizens United, investments in alternatives have absolutely exploded,” said Chris Tobe, a former trustee for the Kentucky Retirement System. Wall Street firms can now write big checks to a political or party committee to curry favor among elected officials who control pension fund appointments — completely out of the public view. A
new SEC rule that year imposed tight restrictions on political contributions by hedge funds, private equity firms, and others to any public official who could have sway over an investment decision. Yet Citizens United effectively made the rule irrelevant, as money flooded in to proxies instead. Executives at firms managing state pension money gave $6.8 million to the Republican Governors Association in the 2014 election cycle, according to the nonprofit
MapLight, and $151,000 to its Democratic equivalent.
Much of the overreliance on private equity and hedge funds boils down to what Ted Siedle sees as a mismatch between the civil servants, who work for the public pensions, and the salespeople, who show up with their sophisticated marketing materials and pitches that make it sound as if only a small elite is fortunate to get a piece of the hot, new fund they are peddling.
“You’ve got Wall Street marketers with virtually unlimited expense accounts, under orders by their bosses to do anything necessary to win over these government pension officials who control trillions,” Siedle said. “So people living these mundane lives are being flown to five-star hotels in Maui, in Honolulu, in Phoenix, in Puerto Rico, in Bermuda. They’re being flown to New York, where they see the hottest Broadway shows, or they’re in Las Vegas at Cirque du Soleil. I’ve seen everything from trips to strip clubs to helicopter rides over Maui to hot-air balloon rides in Albuquerque.”
Image: Allen J. Schaben/Los Angeles Times via Getty Images
