As originally envisioned, this blog was supposed to be about promoting the local Philadelphia economy. Not a new idea. And by now, one that risks becoming somewhat hackneyed before it has even had a chance to create systemic change.
Typically, when folks think about buying local, they think about farmers and beer. But in essence, the benefits of buying locally apply equally to your local farmer as they do to your local lawyer.
In response to the whole "Too Big To Fail" wackiness, some have advocated that depositors return their money to local banks run by local businessmen as a method of avoiding the craziness that results from selling securitized mortgages to sovereign wealth funds. But that meme seems to have never caught on.
While not written with the tenets of localism in mind, an interesting article addressing pension funds appears in today's NYTimes. The specific issue raised is the recent trend of public pensions of seeking increased returns by investing in international markets. As evidenced by the article's headline - "Public Pension Funds Are Adding Risk to Raise Returns" - the author concerns herself with the increased risks implicated by such a strategy and not the strategy's effects on local economies.
It's interesting in that it provides a convenient foil for my thoughts on the public pension issue.
Conventional wisdom identifies two strategies to fund a public pension plan: taxes and investment returns. The article addresses the latter.
The article explains that "many governments were moving away from the perceived safety and liquidity of the investment-grade market and investing money offshore." The mention of "offshore" is what pique my interest.
If the economy was dynamic and growing, municipalities could rely on future increases in our tax base to account for future pension obligations. Cities like Philadelphia face a much grimmer task. Philadelphia's economy is not dynamic or growing. Since the creation of Philadelphia's pension fund, Philadelphia's economy has steadily shrunk creating an inverse relationship between the city's pension obligations and its tax base. Commentators have analogized the city's pension and the resulting fundamental fiscal imbalance to "the Blob" in that the pension is both "(a) growing and (b) [will eat] everything in its sight."
The inverse relationship between pension obligations and the City's tax base makes a long-term solution to our pension crisis impossible. Unable to count of tax revenues, pension managers are now chasing higher and much riskier returns. The article describes that chase.
Philadelphia is no stranger to chasing risky returns.
Ignominiously, Philadelphia is famous for investing the proceeds a 1999 $1.25B bond in the stock market in hopes that high-flying tech stocks would help erase the pension's unfunded liabilities. Soon after, the tech bubble burst and Philadelphia's pension was left in worse shape than had it done nothing.
Showing just how short the memory is of an average Philadelphia politician, Mayor Nutter attempted to repeat history. In 2008, he hatched a plan to issue a $4.5B bond with the proceeds again to be invested in the stock market. By dumb luck, the stock market cratered before Mayor Nutter had the chance to blow himself up.
As an aside, perhaps Fed economists should consider using the proposals of Philadelphia politicians as a predictor of when asset bubbles are about to burst?
As evidenced by the ink devoted to it by the NYTimes, the fact that public pensions are chasing riskier investments is interesting in and of itself. To mix metaphors, the market is akin to a see saw - for every boat that is lifted, another must sink. Despite what 401k proponents may tell you, financial markets ain't preschool. For every winner, there must be a loser.
From this inherent symmetry, we know that some of these pensions will blow up chasing returns derived from riskier investments. The pensions that will be left standing will simply be the lucky few that benefited from the fallen.
Though they may never say it, policy makers knowing there is not enough money to go around. If policy makers ever approached the problem with a cold eye, they would realize that they are in essence facing a decision as to which pensions will survive and which pensions will default on their obligations. Rather than leave it to some incompetent pol to make the decision, it seems to me that this chase of increased returns by taking on additional risk is no more than letting the randomness of markets decide which funds survive and which funds perish. The strategy of chasing higher returns is simply a proxy for a coin flip.
All that said, I'm not all about advocating political nihilism. I'm not saying that we have yet reached the point where we must flip that coin. Rather, my idea being perhaps there is a third way. To save public pensions, we must do more than simply balance risk with return. The pension manager's decision tree ought to be augmented with a third consideration - the effect of investment decisions on the local tax base.
Presently, no weight is given to whether pension investments are consistent with Philadelphia's long-term interests. By "investing money offshore" as described by the NYTimes article, our current public pension plan drains capital necessary to sustain their underlying tax base. Leaving less money available for local business, this strategy stifles a region's long-term business growth. The strategy exacerbates the inverse relationship between pension obligations and its tax base. In other words, it is self-defeating.
To create a sustainable local economy capable of supporting its pension obligations, pension fund managers should consider the effect of their investment decisions on the local tax base. As evidenced by Pennsylvania's Ben Franklin Technology Partners, investing in local businesses does grow the local tax base.
Ben Franklin Technology Partners allocates tax dollars to invest in early stage companies located within our state. In addition to creating a multitude of jobs that grow the region's tax base, Ben Franklin Technology Partners makes money on its investments. The Pennsylvania Economy League reports that Ben Franklin Technology Partners returns to PA's coffers $3.50 for every $1.00 invested.
In the most recent state budget, Harrisburg slashed funding for initiatives like Ben Franklin Technology Partners. Why not make up for those lost funds with some portion of the city's pension fund? Why not allow Philadelphia's employees to benefit from Ben Franklin Technology Partners' investment strategy?
Taking the idea further, why not create something akin to a pension TIFF whereby pension funds invested locally get the benefit of not just the direct investment returns but also the benefit of the increased tax revenues created by the investment activity?
In any event, it's not just increased risks with which we should be concerning ourselves. Perhaps its time to reevaluate the entirety of our public pension system. After all, why continue an investment strategy that not only carries with it a substantial risk of ruin but also undermines our long-term fiscal health?