Pension Reserve Funds can be a source of controversy; the political nature of retirement systems mean that these funds are vulnerable to political interference. For example, in the late 1990s the Clinton Administration considered investing the U.S. Social Security Trust Fund in equities. However, the proposal was torpedoed due to fears that politicians would have influence over the investments, intrude on the Trust Fund’s operations, and engage in ‘stock picking’ so as to use Social Security assets for personal or political gain. The end result would be wasted wealth.
For those of us that think the US missed an opportunity in the 1990s; that pension reserve funds are actually quite a good idea (if properly structured); that they can help shore up underfunded retirement systems; the news coming out of Ireland today is quite depressing.
According to Dara Doyle and Colm Heatley of Bloomberg, Ireland’s banks need $43 billion (!) in new capital. If they don’t get it, they could face collapse / nationalization. As FM Brian Lenihan said,
“Our worst fears have been surpassed…Irish banking made appalling lending decisions that will cost the taxpayer dearly for years to come.”
It’s not just his worst fears; it’s all of our worst fears about how the assets in pension reserve funds can be misappropriated, misused and, ultimately, wasted (albeit this is from the strict perspective of the pension system). Indeed, in this case it’s not just the banking system that will suffer. In 2009, the Irish Government directed the National Pension Reserve Fund to invest in failing Irish banks for recapitalization. However, given the need for another large recapitalization today, the NPRF’s investment will likely end up being wasted.
At the time, Lenihan defended his decision to use pension assets in this manner by saying he wants
“to keep jobs going, to keep people in their homes, to allow people to buy motor cars and to do all the other things that we need to do in our economy.”
Laudable but misguided, in my opinion. The original legitimacy of the NPRF was based on the fact that this fund would not be touched (at all) through to 2025. It was set aside to mute the looming impact of a pension crisis…not to mute the impact of the financial crisis. I recognize that Ireland tapped the NPRF out of pure desperation — Iceland had just gone down and people were beginning to speculate that Ireland would follow suit. But I’m frustrated to see directed investing (once again) come back to cost pensioners and taxpayers so much money.
In my view, when a government sets up a pension reserve fund, it needs to place sufficient constraints over political interference to avoid this type of directed investing. I’ve said this before, but I think the Canada Pension Plan Investment Board has the right model. The political requirements for changing the CPPIB mandate are even greater than for changing the Canadian constitution! Canadian legislation ties politicians’ hands with respect to the CPPIB; there is almost no possibility of being tempted to use the money for other purposes than pensions. This is a necessary political condition for the CPPIB’s existence.
So, while some of Irish Banks may manage (just) to avoid nationalization, you can be sure that the NPRF’s investments will be diluted and discounted to keep these banks running. In other words, a political move cost the pension system money; this is pretty much exactly what US politicians feared back in the 1990s.