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Tuesday, March 24, 2015

Replace public pensions with 403b (401k)

West Virginia state government offers employees a wonderful pension -- a multiplier of 2% for every year worked. Thus an employee who works 30 years gets 60% of the average of their best years in pay.

That is unless the state defaults on its pension plans. It could. For every $3 it has promised state employees, it has socked away only $1.78. And they do not have Social Security to cover their state years because they did not pay Social Security.

The state has a $5 billion deficit! Its defined benefit plan is only 64% funded.

The state -- and its employees -- would be better off with a defined contribution plan such as 403b (their version of the 401k), a scaled-back pension, and an end to the Social Security exemption. All employees would need to do with their money is follow Warren Buffett's advice and put most of the money in a stock index fund.

The state is a terrible manager of pension money. The first 200 names in the Charleston phone book would do a better job than a 64% funding. More importantly, the 40,000 state employees plus 20,000 schoolteachers in West Virginia could do a better job individually because it would be their money they would be investing.

That 64% funding is after 20 years of a 40-year plan to make the pension plans solvent. This catastrophe is costing taxpayers. For every $10 collected in state taxes, nearly $1 goes toward catching up on the pension plan. That is nearly $400 million in tax money every year that does not go to building better schools, better roads and prisons. Indeed, the state is going back to the failed policy of letting felons out early so it can avoid paying $200 million to build a new prison. The cost instead will be paid by victims of murder, rape and mayhem as at least 20% of those criminals return to their craft.

Nor does that nearly $400 million a year go to pay raises for employees.True, they get 60% of their pay after 30 years -- but that is 60% of a paycheck that often skipped even a COLA raise.

This is the story nationwide.

In New Jersey, lawmakers agreed to give $5 billion a year for seven years to its pension funds in an effort to make their plans solvent. That is 14% of the state budget.

And Calpers -- the California state pension plan -- is a bigger mess.

"Calpers has $255 billion in assets to cover present and future pension obligations for its 1.6 million members. Yes, but in March, Calpers Chief Actuary Alan Milligan published a report suggesting that various state employee and school pension funds are only 62%-68% funded 10 years out and only 79%-86% funded 30 years out. Mr. Milligan then proposed — and Calpers approved — raising state employer contributions to the pension fund by 50% over the next six years to return to full funding. That is money these towns and school systems don't really have. Even with the fee raise, the goal of being fully funded is wishful thinking," wrote Andy Kessler, a former hedge fund manager, in the Wall Street Journal.

62% to 68% funded?

Welcome to wild, wonderful West Virginia, Calpers.

Andy Kessler is pushing for defined contribution plans -- 401k and IRAs -- for public employees. They can do better. As Andy Kessler pointed out, states and private employers are lousy managers of money.
 I recall a conversation from 20 years ago. I was hoping to get into the money-management business at Morgan Stanley. I wanted to ramp up its venture-capital investing in Silicon Valley, but I was waved away. It was explained to me that investors wanted instead to put billions into private equity.
One of the firm's big clients, General Motors, had a huge problem. Its pension shortfall rose from $14 billion in 1992 to $22.4 billion in 1993. The company had to put up assets. Instead, Morgan Stanley suggested that it only had an actuarial problem. Pension money invested for an 8% return, the going expected rate at the time, would grow 10 times over the next 30 years. But money invested in "alternative assets" like private equity (and venture capital) would see expected returns of 14%-16%. At 16%, capital would grow 85 times over 30 years. Woo-hoo: problem solved. With the stroke of a pen and no new money from corporate, the GM pension could be fully funded — actuarially anyway.
Things didn't go as planned. The fund put up $170 million in equity and borrowed another $505 million and invested in — I'm not kidding — a northern Missouri farm raising genetically engineered pigs. Meatier pork chops for all! Everything went wrong. In May 1996, the pigs defaulted on $412 million in junk debt. In a perhaps related event, General Motors entered 2012 with its global pension plans underfunded by $25.4 billion.
The vaunted GM defined benefit plan wound up in the tank. Not only did this mean some employees take pension cuts but taxpayers paid $50 billion to prop up GM's pension plan.

Defined benefits plans -- promised pensions -- have been a problem for at least a half-century. Contrary to union propaganda, those pensions are not guaranteed to be paid in full. Here is the list of the major pension plans now run by a government agency, which pays retirees less than promised:

Allegheny Health, Education & Research
Allis Chalmers
Amcast Industrial Corporation
Anchor Glass
Arrow Automotive
Bethlehem Steel
Caldor Corporation
Circuit City
Collins & Aikman
Cone Mills
Consolidated Freightways
Delphi Corporation
Delta Pilots
Dewey & LeBoeuf
Durango Apparel
Eastern Air Lines
Fairchild Corporation
Foamex LP
Forum Health
Grand Union
Hartmarx Corporation
Harvard Industries
Hawker Beechcraft
Hayes Lemmerz International, Inc.
Henry I. Siegel Co.
J. A. Jones
Jacobson Stores
Kaiser Aluminum
Kaiser Steel
Lehman Brothers
LTV Steel
Metaldyne Corporation
Milacron Inc.
National Steel
Nortel Networks, Inc.
Northwestern Steel and Wire
Outboard Marine
Pan Am
Payless Cashways
Penn Traffic
Piccadilly Cafeterias
Reliance Insurance
Republic Technologies
Saint Vincent Catholic Medical Centers
Singer Company
Thorn Apple Valley
United Airlines
United Merchants and Manufacturers
US Airways
Weirton Steel
Westpoint Stevens
Wheeling Pittsburgh Steel

Now tell me again how much better defined benefits are than allowing each worker to manage his own nest egg.

In his column, Andy Kessler pointed out that Calpers invested its money in bonds -- the same thing that tanked West Virginia's defined benefits plan. It was not until 1998 that West Virginia could invest in the stock market! And bonds were not safer. In 1989, state Treasurer A. James Manchin resigned after losing $279 million in the bond market, and his manager of the pension fund went to jail for his incompetence. Hint: If you lose $279 million on reverse re-purchase agreements do not -- repeat not -- lie about it.

Andy Kessler said as long as Calpers has bonds that it pay only 1.74% annually, it will not meet that 7.5% goal it has.

But 7.5% is a piece of cake on the stock market.

Put it in a stock index fund. This isn't difficult. You pay Vanguard 5 basis points (a nickel for every $10 invested) to manage the money in a fund that has an average annual rate of 7.87% for the last 10 years.

Vanguard is as lazy as I am. It invests your money to correspond with the stocks in the S&P 500 Index. They have averaged 7.87% for the last 10 years.

And mind you, this comes during the worst 15 years in the life of the stock market. Over the last 35 years, the S&P has averaged a rate of return of 11.87% annually.

If you invested $1,000 in 1980, it would be worth more than $50,000 in 2014.

But what if the stock market crashes?

That's a  buying opportunity. I survived the crashes of 1987, 1991, 2000, and 2008.

Since 1871, the stock market has averaged 9.11% annually. That is after the Panic of 1873, the Panic of 1893, the Panic of 1907, the post-World War I depression, the Great Depression, the post-World War II recession, recessions in 1958, 1973, 1973, 1979, 1982, 1987, 1991, 2000, and 2008. I may be missing a few.

The Russell 1000 and other many other stock indices do even better!

But don't believe me. I am a mere hundredaire. Here is what Warren Buffett wants the charities to do with the loot he will leave them when he dies: "My advice to the trustee couldn't be more simple: Put 10% of the cash in short-term government bonds and 90% in a very low-cost S&P 500 index fund. (I suggest Vanguard's.) I believe the trust's long-term results from this policy will be superior to those attained by most investors — whether pension funds, institutions or individuals — who employ high-fee managers."

You can do better than the state. So can state employees.

To recap, cut the pension in half, provide Social Security, and encourage 403b. They will be better off because their 403b money will be bigger than their half their pensions -- plus it can be passed along to heirs. I would keep the pension and of course, Social Security, because they are stabilizers.

Why does this work? Because, comrade, defined benefit plans are socialist and pushed by unions. Defined contribution -- investing your money -- is capitalist. Socialism does not care about the individual. Capitalism is tailored to him. It's called self-reliance. Governments hate it.

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