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The Grey Lady Wrings Her Hands over Public Pensions

Walter Russell Mead

The NYT editorial board has come as close as it can to the devastating realization that blue model governance is breaking down. In a recent editorial, the Grey Lady notes that hedge funds chosen by public managers often underperform relative to expectations. As the industry has grown, the hedge funds continue to charge extremely high fees, but their returns increasingly don’t justify what they charge, and the mangers who have listened to the siren songs of slick hedge funds haven’t done well:

A recent report in The Times by Gretchen Morgenson cited the latest research on pensions and hedge funds. One study, by researchers for the American Federation of Teachers, looked at hedge fund holdings in 11 large public pensions between 2002 and 2015, and found that hedge funds lagged overall plan performance in most years, costing the pensions an estimated $8 billion in lost investment revenue. The hedge funds, meanwhile, collected some $7.1 billion in fees, which averages out to 57 cents for every dollar the pensions kept on their hedge fund investments. In effect, the pensions were looted.

One obvious question is why pension managers keep investing in hedge funds. A common explanation is that pension trustees are naïve and desperate and easily outfoxed by Wall Street salespeople. There are also signs, however, of willful blindness.

The editorial contains the inevitable slash at the greed and deceptiveness of Wall Street, but that part feels tired and pro forma. Even the NYT can’t fail to observe that this dynamic involves failures of governance on the part of the trustees of public pension funds. Either the trustees are stupid and credulous, or they are “willfully blind”—they choose to ignore the risks and odds because they need to throw Hail Marys to get the kind of returns they need to meet their unrealistically aggressive growth targets.

This is another way of saying that public sector unions—and state and municipal governments—have made promises to workers about their pensions without setting aside enough money to fulfill those promises when they came due. As a result, pension managers are forced into the casinos to make risky bets. But because they tend to be among the stupidest players in the financial market, they all too often end up getting hosed.

This is a diagnosis that readers have read in these pages, and it is good to see that Times editorial board agrees. What we wish the board would do is to press that analysis a little bit further to the wider conclusions. Why would cities and states have made such unsustainable promises for so long to so many workers? And why haven’t the unions been crying bloody murder about the systematic underfunding of their members’ pension programs?

These questions drive you to confront the deep political and moral failures at the heart of the blue governance model. The leadership of public service unions needs to show its members that it gets results, but cities and states increasingly do not have the money to pay the big salary increases that the unions want, at least not without raising taxes to ruinous (and, for politicians, ruinously unpopular) levels on the one hand or without cutting services and programs to the bone on the other. But the unions still want something to show to the members. What’s the answer?

Over and over again, the answer is large but unfunded pension promises. Union leaders can posture to their members about all the lovely bacon they are bringing home, and politicians can posture to the taxpayers about how fiscally prudent they have been. The game depends on the unions shutting up about the underfunding of the pensions. If the politicians had to fund the pensions at the real level of these promises, they couldn’t make the promises.

And so it goes. The Ponzi scheme at the heart of state and local governance, requiring deliberate deceit of both voters and public employees, continues.

The Gray Lady, to her credit, realizes that something terrible has happened, and she is doing what she does best: sounding the alarm. But she is still doing her utmost to pretend that there is no real cause for this terrible, multi-trillion dollar hole in the pension system. She sees no systemic flaw in the way that the modern progressive city and state are both designed, no structural defect that produces these terrible consequences in cities as different as Houston, New York, Chicago, and Los Angeles, and in states ranging from tiny Rhode Island to giant California, New York, and Illinois.

The ship is sinking, but the Times is only prepared to deplore bad behavior without drawing any wider conclusions. And there is something else that the Times hasn’t fully taken on board: the consequences of the pension meltdown for the balance of power in American politics. For the next few decades, cities like Chicago and states like Illinois will be coming, à la Puerto Rico, cap in hand to Washington, asking for national taxpayers to fill the gap that their own bad choices and poor planning created. Much of blue America (including many blue cities in red states) is going to be asking red America for bailouts. That is likely to lead to a shift in political power and political initiative.

Scott Walker’s presidential bid was a flop. But the kind of wrenching political changes that he brought to Wisconsin are likely to be happening in more and more places. As the fiscal consequences of the collusive union politics in blue cities and states become harder to ignore, the demand for deep reform is going to grow. These painful but, so far as one can see, inescapable realities that the editorial page of the Times is not ready to acknowledge today will drive the news in the rest of the paper tomorrow. The blue social model is running out of safe space.

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