I have written before about how public pensions are being looted by a combination of malpractice by elected officials and greed by investment banks and advisors. The way it works is like this. In order to for the pension funds to be solvent enough to pay out the promised benefits, the elected officials have to set aside a certain amount of money in highly rated securities that have lower returns. What some elected officials do is to divert some of that money to cover expenses since the tax-cutting mania has resulted in local governments not having enough money to meet their needs. Then when the pension funds run low, these elected officials turn to investment firms that promise high rates of return that they say will make up for the shortfall.
But sometimes, unless they are restricted by law, these securities can be riskier and often do not return the promised rates. But the investment advisors don’t care because where they make their money is by siphoning off huge amounts of money as fees, making the deficit hole even larger. Patrick McGeehan writes that pension funds are losing up to $2.5 billion as fees paid to Wall Street.
The Lenape tribe got a better deal on the sale of Manhattan island than New York City’s pension funds have been getting from Wall Street, according to a new analysis by the city comptroller’s office.
The analysis concluded that, over the past 10 years, the five pension funds have paid more than $2 billion in fees to money managers and have received virtually nothing in return, Comptroller Scott M. Stringer said in an interview on Wednesday.
“We asked a simple question: Are we getting value for the fees we’re paying to Wall Street?” Mr. Stringer said. “The answer, based on this 10-year analysis, is no.”
Until now, Mr. Stringer said, the pension funds have reported the performance of many of their investments before taking the fees paid to money managers into account. After factoring in those fees, his staff found that they had dragged the overall returns $2.5 billion below expectations over the last 10 years.
“When you do the math on what we pay Wall Street to actively manage our funds, it’s shocking to realize that fees have not only wiped out any benefit to the funds, but have in fact cost taxpayers billions of dollars in lost returns,” Mr. Stringer said.
…Most of the funds’ money — more than 80 percent — is invested in plain vanilla assets like domestic and foreign stocks and bonds. The managers of those “public asset classes” are usually paid based on the amount of money they manage, not the returns they achieve. [My emphasis-MS]
Wall Street never misses a chance to rip you off coming and going.
“Managers” at other levels also exact a cost.
For example, just as Enron was going down the tubes in late 2000, the Florida state employees’ pension fund bought into it big time. I doubt any of the professional financiers involved thought that was a good idea, but they found themselves overridden by a well-connected fellow named Jeb! Bush whose inside track with Ken Lay & Co. no doubt persuaded him to invest because either the stock would recover and he would look good, or it wouldn’t and nobody would remember later.
There are several problems to deconstruct here.
First, from the linked article, the pension funds have exceeded their projected growth. So the money which was invested performed better than expected. So far, so good. The pension funds have not lost money. Unfortunately, the amount by which the funds exceeded the projections was almost entirely eaten up in fees.
But the pension funds are still in the black.
So what we are really talking about is that money which exceeded the projections has not been added to the pension fund. It would be nice to have extra money, but as long as you are meeting the projections, it seems that the retirees have little to worry about.
But going a bit further, we already know that paying people on commission creates an incentive to have as many transactions as possible, regardless of the outcome for the parties involved in the transaction. It doesn’t matter if you are buying a blouse at a clothing store, or a house using a realtor, or stocks through a broker. The middle-man in every case is going to pressure you to buy because it’s only when transaction occurs that they get paid.
So commission sales, where the broker takes a percentage of the transaction should be phased out.
On the other hand, what has been suggested is to base pay on performance. This is also a problem because just how do you do that? In a brokerage house, performance on a single fund will vary year-by-year. So does the customer get money back when the fund drops below the expected return (which it an readily do)? If so, where does that money come from? The brokerage house? The individual brokers who were getting bonuses when the fund was doing well?
The solution to that problem has been to suggest that brokerage houses should charge flat fees for transactions (not based on the amount of money moved, but for simply making the transaction), and possibly a management fee for accounts which have few transactions each year, to help pay a salary to the brokers for doing their job.
But what are their salaries? Reasonable? Excessive? I would accept $250,000/yr as on the high side of reasonable, but $10,000,000/yr seems a bit excessive. I know that most of those salaries are not public knowledge, but anyone who wants to place public money into the hands of a brokerage house should be able to get a general idea of the salaries they pay.
Or, better yet, create a dis-incentive for people to collect large amounts of income. Bring back the Eisenhower Era level of income tax, and you would see people voluntarily cap their salaries to prevent the federal government from taking 90% of each additional dollar in income as taxes. If the fund managers who are making $10,000,000/yr voluntarily capped their income at $4,000,000/yr, how much of the 2.5 billions dollars would have been lost?