Deroy Murdock is a co-founder of Third Millennium and a member of the Cato Institute’s Advisory Board on Social Security Privatization. A shorter version of this article appeared in The American Enterprise.
In his State of the Union address, President Clinton proposed to invest some $700 billion of the Social Security Trust Fund in corporate equities through 2014. Give the President credit for finally conceding that the largest federal program generates returns that would cost a Wall Street money manager his job. However, Clinton’s scheme to make Uncle Sam the biggest trader on Wall Street is riddled with economic and political perils.
True, pumping public pension money into stocks promises better returns than do Special Issue Treasury Notes, the non-marketable IOUs that accumulate as Washington spends today’s FICA taxes on foreign aid, food stamps, and more. However, individuals who invest their assets privately tend to see them outperform those supervised by government functionaries. Unlike private portfolio managers—who legally must maximize returns for future retirees—public pension administrators often pursue other agendas. Many strive for “collateral benefits,” as former Labor Secretary Robert Reich endearingly calls them, such as “affordable housing, infrastructure improvements and jobs.”
According to Marquette University finance professor John R. Nofsinger, these “economically targeted investments” (or ETIs) typically reduce average annual yields by 1.5 percentage points below their expected returns. Alicia Munnell, a former Clinton Treasury official, discovered that the returns from pension investments funneled into home-ownership programs fell between 1.9 and 2.4 percentage points annually. With compounding, such seemingly small gaps swell into wide gulfs between the retirement incomes of workers who control their assets and those whose futures are left to bureaucrats.
But the menace of government equity ownership goes beyond rates of return. President Clinton’s desire for a Social Security portfolio “free from politics” is fanciful at best, another lie at worst. In a January 28 Senate Budget Committee appearance, Federal Reserve Chairman Alan Greenspan hosed down this idea with ice water. Federal investment of FICA funds, Greenspan said, “would arguably put at risk the efficiency of our capital markets, and thus our economy.” He also was metaphysically skeptical of politically neutral government investment: “Even with Herculean efforts, I doubt if it would be feasible to insulate, over the long run, the trust funds from political pressure—direct and indirect—to allocate capital to less than its most productive use.”
Social Security’s cheerleaders call privatizers paranoid for imagining that the Clinton administration might, for instance, liquidate Microsoft and Philip Morris shares to express solidarity with Macintosh users and nonsmokers. But the privatizers reply that politically driven public investment is all too common in cities and state. These include assets “targeted” at local economic development, as well as politically correct investment decisions that promote pet causes. Some officials simply have misallocated pension funds. Add to this mix the usual graft and corruption that make government itself such a dreary proposition.
State efforts to steer pension assets into local economic activity have imploded as if they were abandoned public-housing projects. In recent years, according to Heritage Foundation analyst Daniel Mitchell, the Kansas Public Employees’ Retirement System lost $65 million in the Kansas-based Home Savings Association, $14 million in Tallgrass Technologies, and about $8 million in a local steel mill. With at least $138 million in losses, this economic targeting missed the bull’s-eye by miles.
In 1988 the Missouri State Employees Retirement System launched a venture-capital fund to lure companies to the Show-Me State. Three years and two lawsuits later, the failed fund was shown the door. In 1990, the State of Connecticut Trust Fund spent $25 million for a 47 percent stake in Colt Industries, a local gun maker. In 1993, Colt misfired, and the money vanished.
According to the Cato Institute’s Michael Tanner, 42 percent of state, county, and local pension fund systems currently practice this kind of cronyism. Such ETIs, Yale law professor Roberta Romano reports, generated $28 billion in losses between 1985 and 1989.
Politically Correct Investment
As if incompetent investment were not enough, public portfolios also are battered by politically correct decision-making. Public equity ownership became a white-hot political potato during the divestment movement of the mid-1980s. At least 30 states and many more cities and public universities ditched their shares in companies that conducted business in apartheid-era South Africa. (Perhaps in the name of equal opportunity, 11 states also curbed investments in firms that violated the “MacBride Principles” governing commerce in Northern Ireland.)
Tobacco, of course, is a smoldering bugaboo for public pension managers. Minnesota lost $2 million last year when its employees’ fund dumped its tobacco holdings. Some public managers have done more than simply wash the tobacco stains off their hands. On April 10, 1998, New York State Comptroller Carl McCall said he would withhold his support from the boards of Philip Morris, RJR Nabisco, and Loew’s at shareholders’ meetings if they did not “reach a prompt settlement that effectively reduces youth smoking and ends the lingering controversy. . . . It is not in the best interest of the tobacco companies to just stop talking to Congress.” New York’s state pension fund then owned 11 million shares of those firms’ equities worth some $450 million.
Conservative activists have joined in the fun, too. The American Family Association of Texas sent the State Board of Education taped highlights of recent films distributed by Miramax, a Walt Disney subsidiary, including the violent hit Pulp Fiction. On July 9, 1998, the board decided to sell the $46.4 million of Disney stock in its Permanent School Fund. “It’s not Mickey Mouse and Donald Duck anymore,” board member Richard Neill said at the time. “It’s blowing people’s heads off.”
Political pressure needn’t be applied to be effective. Like a cocked gun that is never discharged, the mere threat of a politically inspired investment decision can advance desired outcomes. When politicians snarl, executives dive beneath their desks.
On July 2, 1998, Carl McCall and New York City Comptroller Alan Hevesi threatened to exclude Swiss banks and financial advisers from managing municipal pension funds and other state assets. McCall and Hevesi wanted the Swiss to settle a lawsuit with Jewish groups involved in the Holocaust-era dormant accounts controversy. The Swiss banks caved in like chocolate soufflés. “The first set of measures was supposed to begin September 1,” a Swiss source close to the talks told me. “That boycott schedule had an impact on the speed of the negotiations, without a doubt.” The final deal was unveiled August 12, 1998, just five weeks after McCall and Hevesi huffed and puffed.
While Congress routinely squanders tomorrow’s Social Security assets on today’s goodies, state and local officials have learned from the big boys. In 1997 California’s Supreme Court let stand a lower court ruling that Sacramento had violated public employees’ rights. Then-Governor Pete Wilson and the state legislature diverted $1.36 billion in pension contributions to balance the state budget in fiscal years 1993 and 1994. New York State similarly siphoned $230 million from its employees’ retirement fund in 1995. In the summer of 1998, Chicago authorities used $12.5 million in pension contributions for interest payments on a $175 million infrastructure bond issue.
Can anyone trust Congress and the White House not to use a federal pension portfolio to balance future budgets? This $700 billion honey pot also will attract lobbyists and PAC men like grizzly bears. This would be a golden opportunity for presidents and congressmen to sell “access” to Wall Street firms—one banquet table at a time.
Free-marketeers should be frightened by those who already are licking their chops over what could become government’s biggest chow-down yet. Savoring this potential federal feast, Representative Jerrold Nadler told The Village Voice: “You’re saying the government will have more influence to pressure for more decent, socially responsible corporate behavior. That’s terrible?” The AFL-CIO’s Gerald Shea predicts federal investment will “have a good effect on how corporate America operates.” That depends on what your definition of “good” is.