The Great Pension-Bonus Giveaway Fiasco

Megan McArdle is a Bloomberg View columnist. She wrote for the Daily Beast, Newsweek, the Atlantic and the Economist and founded the blog Asymmetrical Information. She is the author of "“The Up Side of Down: Why Failing Well Is the Key to Success.”
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Over the past month or so, readers have asked me to comment on Matt Taibbi's article about public pensions. I have various issues with his version of events, but his fundamental point -- public pensions should not be investing with hedge fund managers -- is quite sound. They shouldn't be investing with hedge fund managers.

The difference between me and Taibbi is that I see public pension officials making bad decisions not because they're deluded right-wing ideologues, but because they and their predecessors, and the legislators who made the pension laws, made a bunch of awful decisions that have left them with few good options. Plunging pension assets into hedge funds and similarly risky investments was a Hail Mary pass to save a failing system.

The problem is that, unlike most Hail Mary passes, this one could actually make the pension situation much worse. Hedge funds took huge fees for their troubles, and riskier investments can underperform as well as overperform. Those desperate pension managers may have -- and in some cases, definitely have -- taken a bad situation and made it worse.

For that, I do think we can blame the professionals, as well as the pension managers -- and not just the hedge fund managers. I've been shocked to find out how common "extra payments" or "13th checks" have become among public pension funds. Basically, when returns were higher than the projected average return (generally around 8 percent), they funneled off the extra into a bonus check. This is ... well, gee, profanity is too weak. It is an insane mangling of the concept of an "average return." As should be obvious to anyone who sat through high school math, that average is composed of some years when the return will be higher than the average, and some years when it will be lower. You can't siphon off the "excess" returns from the up years unless you also put in extra cash during years when the market underperforms. It goes without saying that they did not top up during the bad years. The result is the current mess in Detroit, and elsewhere.

The pension trustees who authorized this deserve all the shame and opprobrium we can heap on them, and I've done my fair share of that. But what about the actuaries who enabled them? The defense they mount to the New York Times is that they weren't fiduciaries. Okay, but you stood by and let pension trustees destroy the actuarial soundness of the funds, when you should have told them -- and anyone else who would listen -- that the whole thing was a disaster waiting to happen.

Even if you do not have a fiduciary obligation, you do have a moral obligation to do what you can to stop feckless trustees from further eroding an already weak pension. Pensions should be invested in low-risk assets, and the shortfalls that this will inevitably entail should be made up by higher contributions, not taking on extra risk with someone else's retirement. Financial advisers should not be helping anyone to make a Hail Mary pass when the game still has a lot of time left on the clock.

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