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Pensions, Profits & the “Mortgage Crisis”: Lessons against privatizing Social Security

by Monica Davis
The Wall Street mortgage meltdown is teaching proponents of privatizing Social Security that there ain't no such thing as a free lunch. Wall street investment of social security funds are no guarantee.
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Pensions, Profits and the “Mortgage Crisis”—Or, a hard lesson against privatizing Social Security

While a certain segment of our editorial writers are lumping hot coals on the heads of “people who bought houses even though they could not afford mortgages” and blame greedy home buyers for biting off more mortgage they could chew, a bigger crisis is looming on the horizon. Pension plan instability.

Long before most of America knew anything about ‘subprime loans’, many of the nation’s pension plans were in trouble. They were often under-funded and teetering on the brink of insolvency.

And, should they fail, by its own admission, the federal agency tasked with bailing them out doesn’t have enough funds rescue them. Now we come to a situation, which adds even great possibilities for pension plan failure: a major crisis on Wall Street, due to the institutional sale of mortgage based secured investment products. These instruments were sold to banks and institutional investors around the world and have now lost much of their value.

The mortgage crisis is hitting many of the nation’s pension plans, whose investment portfolios have been devalued because of their investment in these risky mortgage backed securities. According to a former Miami Herald business writer: “A key example (of the effect of the collapse) is the Local Government Investment Pool in Florida, which had to be frozen after municipalities made huge withdrawals over subprime exposure.” (Miami Herald 1-7-08)

Greg Fields, the Miami Herald reporter, goes on to say, “But other states, including New York, Maine and Connecticut, have had their fiscal cages rattled by subprime problems. The Ohio Police and Fire Pension Fund, for instance, moved 7 percent of its portfolio into mortgage-related securities.” (Ibid)

Fields’ argument basically goes after those who want to privatize Social Security. He uses the effect of the mortgage meltdown on investments, retirement plans and pensions to argue against privatizing Social Security. In his view, Wall Street has no special mojo when it comes to Social Security.

Simply put, it all goes back to basic economics: risk and profit. Those who risk a lot stand to gain a lot—they also risk losing their shirts.
Much has changed in the one hundred years since American Express began the first private pension plan in the United States, according to news analyst and university professor, Cathy Gill:
In the United States, American Express established the first private pension plan -- an employer-run retirement program -- in 1875. General Motors implemented the first modern plan in the 1940s. Then in 1963, Studebaker closed the doors of its South Bend, IN plant; in the process, it terminated its employee pension plan (employees and retirees were among the highest paid in the automotive industry). Only a third of the 10,500 workers received full benefits; almost half received 15% and almost a third received nothing.

The aftershocks led to Sen. Jacob Javits (R-NY) to introduce pension reform in 1967. (He also introduced a national health insurance bill.) It took seven years, but in 1974, Congress passed the Employee Retirement Income Security Act (ERISA). President Ford signed the legislation, which created the Pension Benefit Guaranty Corp. (PBGC), guaranteeing workers' benefits in private pension plans. The law also required that pension plan assets must cover liabilities; in this manner, Congress positioned PBGC as be a last resort. Since ERISA began in 1974, more than 160,000 companies have voluntarily ceased honoring their pensions. (“Is there a US pension crisis?”)

An upcoming conference on pensions and investments shows just how critical the situation has become. Pension plans, being ‘very active participants’ in the world’s financial markets now have a need to be “informed investors”, when it comes to placing their investments in what has now become a very risky market. According to conference organizers:
A range of significant developments affecting the landscape of pension investment have arisen in 2007. Of these, impacts of the credit crisis of 2007 on financial markets in which pension plans are very active participants have been widely noted. It still seems unclear whether the crisis has run its full course, and it remains to be seen what changes to structure and disclosure practices are in store in the future for mortgage and other asset-backed financial instruments. On the regulatory front, the public focus on retirement savings through defined contribution plans, the effect that high costs and fees can have on participants' savings balances over time and perceived opaqueness of, and conflicts inherent in, revenue sharing structures that are common for such savings plans have given rise to significant new disclosure requirements. (Pension Plan Investments 2008 Groupcast Location May 1, 2008 Pennsylvania Bar Institute -- Philadelphia, PA)


With the investment industry roiling, we now know that privatizing Social Security, that is putting the nation’s investment dollars in the stock market is not as secure as its proponents would have you believe. It is even more critical for many city employees around the nation:
Employees who participate in a defined benefit pension plan look forward to receiving their accrued benefits at retirement. For city employees, these vested, accrued benefits are a contractual obligation between the city and the worker that can't be denied. Unlike participants in private pension plans, municipal employees have no federal agency, such as the Pension Benefit Guaranty Corp. (PBGC), that insures or guarantees their pension benefits. There's no one to bail them out. (James B. Davis, “The Funding Crisis in Municipal Pensions”)
It looks to be the beginning of a Wall Street bloodbath, as pension plan managers who lost big time with investments in the mortgage-backed securities get their walking papers.
The State Street Corporation, which manages $2 trillion for pension funds and other institutions, ousted a senior executive on Thursday and said it would set aside $618 million to cover legal claims stemming from investments tied to mortgage securities. (New York Times, 1-4-08)
The same article noted the fall out from investors who have sued various brokerage houses for selling the securities. This problem has worldwide implications:
Last month, a town in Australia sued a unit of Lehman Brothers for selling it collateralized debt obligations that lost 84 percent of their value, a charge refuted by the firm. In Norway, Terra Securities filed for bankruptcy protection in November after regulators revoked its license for selling risky American securities to a cluster of towns near the Arctic Circle. (Ibid)
The legal knives are sharpening around the world, as investors gear up to sue various and sundry investment and brokerage firms. There is a massive wave of litigation in the works, according to experts.
It is hard to predict how far the impact of this credit crunch will spread, but it is clear that it will spread well beyond home buyers and their lenders. With the enormous growth in the mortgage backed securities markets during the last few years, the risk of a declining real estate market is spread to many businesses who do not think of themselves as participating in the real estate market. Understanding the risks and the efforts of those affected by the falling real estate market to shift their losses to others is the first step in preparing for the inevitable change that is upon us. (The Metropolitan Corporate Counsel, “What The "Subprime Crisis" Really Means For Your Business”, Philip R. White and James M. Hirschorn Sills Cumnis & Gross, P. C.)
While the legal eagles are gearing up for what may be a goldmine for law firms, many of the pension plans and investors who have lost billions to date, have only felt the leading edge of this financial hurricane. The other shoe hasn’t dropped yet—just wait ‘till the ’08 and ’09 mortgages come due and go into foreclosure.








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