PENSION RISK COULD MAKE SCHMUCKS OF SAVERS / THE FINANCIAL TIMES OP EDITORIAL

Pensions risk could make schmucks of savers

Post-crisis, banks have become safer but the dangers have been pushed elsewhere

John Authers


Former Lehman Brothers chief Richard Fuld encounters protesters in 2008 following the collapse of the bank © Reuters


When Richard Fuld, the chief executive of Lehman Brothers, received the news in 2008 that no one would ride to the rescue of his failing bank, he is reported to have said: “So I’m the schmuck?”

Almost a decade later, Lehman is still the only US investment bank that was allowed to fail. Its peers have been restored to health with risks removed. Mr Fuld appears to be the ultimate “schmuck” of the financial crisis. But that judgment may be premature.

Risk has been gently and painlessly excised from the US banking system over the past 10 years. On any sensible measure, US banks are far safer now. Europe’s banks, which entered the crisis in a far more parlous state, have at least improved. The nightmare scenario, which seemed very close in 2008, of all-out banking collapse seems now to have been averted. The prospect of ATMs failing to pay out cash, or of companies failing to pay wages, has receded.

While risk no longer sits in the banking system, it has not vanished. It grows ever clearer that risk has been moved, primarily to the pension system. This means that the long-term dangers in the financial system have become more insidious: easier to ignore but ultimately even more dangerous.

Pension funds have been the principal losers from quantitative easing, the main tool used to bail out the banks. QE bond purchases pushed down bond yields. This created pain for pension funds, which buy bonds to offer their members a guaranteed income. The lower the yield on bonds, the more expensive it becomes for them to fund any given guarantee. This problem has created a true crisis among US public sector pensions. Many are looking for ways out of the guarantees made to their members, only to find that courts — rightly — defend the members.

In the US, pension deficits — the gap between assets and the notional cost of funding the guarantees — widened sharply after the financial crisis. According to Mercer, the consulting actuaries, companies in the S&P 1500 index currently face a pension deficit of $229bn, or 11 per cent of their assets. This number has improved this year thanks to a rise in bond yields. At the worst, this deficit exceeded $600bn, or more than 30 per cent of assets.

QE has passed the buck to pension funds in other ways, too. With bonds barely offering an income, many funds have resorted to taking greater risks. That has meant buying into funds and strategies that go under the umbrella term of “alternative assets”, many of which rely on leverage for their returns.

Private equity has been a principal beneficiary of QE, as it has turned pension funds and other large asset managers into willing providers of capital. According to the tally kept by the London-based research group Preqin, the assets controlled by private equity groups have just passed $3tn for the first time, after growth of more than 20 per cent in the past year.Once the preserve of wealthy individuals, private equity is now principally an asset class for large institutions, with pension funds holding more than half of private equity assets.

Meanwhile, hedge funds have also flourished in the post-crisis years, despite mediocre returns. HFR, the Chicago-based research group, found that total assets held globally by hedge funds have risen to $3.23tn, up from $1.4tn at the end of 2008. Once vehicles for the rich to take risks, they now exist to serve large institutions. The policies that gave US banks the breathing space to make themselves safer also allowed alternative asset managers to sell to a new customer base of large institutions.

There are good reasons for pensions to take the strain. Unlike a banking crisis, a pensions crisis has no one moment of critical danger. Its ill effects settle in over time, and there is opportunity to fix them. To put this more negatively, politicians who want to delay a reckoning can do so if the risk is stashed where it can be ignored, or even left to the next generation to sort out.

The sheer complexity of pensions also helps to make them a much more attractive place to bear risks. Few understand them, so they tend not to be the subject of mainstream debate. But the events of 2008 demonstrated that risks that seem complicated and obscure can soon become very relevant indeed, and the subject of extremely heated political debate. Even if the risk of a sudden banking crash has diminished, the risk that much of the population will be subject to poverty in retirement is growing.

It is difficult to focus on esoterica like this at a time of political anger across the world. But as it stands, pension savers — virtually all of us — may find to our horror that we are the schmucks.