Et Tu New York? What Deregulation Means to Pension Funds

According to Financial Times reporter David Wighton ("Regulation a threat to New York, report says", January 22, 2007), New York City stands to lose nearly 60,000 jobs over the next five years in the absence of significant regulatory reform. A McKinsey & Company report, commissioned by Mayor Michael Bloomberg and Senator Chuck Schumer, extols the virtues of London and other venues that are considered more user-friendly for derivatives trading and other financial service activities.

Mr. Kevin LaCroix, creator of the informative blog, The D&O Diary, provides a link to the report and some interesting comparisons with the Paulson report that likewise pleads for liberalization of U.S. capital markets.

While free marketeers applaud initiatives that permit capitalism to do its magic of bringing together diverse buyers and sellers, consider some recent statistics from the Conference Board.

1. In 2005, U.S. institutions such as pension funds, insurance companies, banks and foundations controlled $24.1 trillion in assets.

2. In 2005, these institutional giants owned 67.9% of the equity of the largest 1000 corporations versus 61.4% in 2000.

3. In 2005, four companies revealed institutional investor ownership in excess of 70%. In 2004, the number was two and one or none before then.

4. Public pension plans continue to prevail in important corporate matters. Co-author of the 2007 Institutional Investment Report (Report #1400, The Conference Board), Dr. Carolyn Kay Brancato, Senior Fellow and Director Emeritus of The Conference Board Governance Center describes their critical role. "Ten years ago, these funds weren't likely to join in lawsuits or exert pressure in out of court settlements, but now, having been severely burned by the Enron and WorldCom situations, these funds are asserting themselves as never before. In addition, as the election of directors becomes more heated, and as many companies adopt bylaws saying their directors will resign if they don't get a majority of shareholder votes, the voting clout of these activist investors becomes more meaningful."

What does this mean?

As stewards of trillions of dollars of retirement monies, pension fiduciaries must serve as the first line of defense with respect to sniffing out corporate misdeeds or identifying boards that are "oversight challenged." Already tasked with a daunting job, deregulation compels these watchdogs to do an even more rigorous search for red flag issues BEFORE they turn into financial calamities.

This goes back to a recurring theme of this pension blog. Do pension fiduciaries have what it takes? On what basis are they selected? How are they trained? Is there a pension fiduciary who can serve as a Sarbanes-Oxley type "financial expert," someone who understands how to go beyond financial statements to detect possible trouble? Are the right mechanisms in place for pension fiduciaries to gather adequate information about corporate policies, procedures and internal controls AND then evaluate the data in a meaningful way? Are fiduciaries compensated in such a way that encourages their active participation, before the fact? How has the role of lead plaintiff changed in the aftermath of the Private Securities Litigation Reform Act of 1995 and can litigation replace regulation?

I'm not saying that statutory regulation is a panacea. In fact, there is great comfort in being part of a system that permits a vigorous debate about the numerous merits of industry self-review.

As patriot Thomas Paine declared: "Those who expect to reap the blessings of freedom, must, like men, undergo the fatigue of supporting it."

Pension Contagion - Should We Worry?

Similar to many of my peers, I spent the last few days in the same shape as this fella. Anxious now to avoid suspicious coughs or sneezes, I've been pondering what contagion might look like in the pension world. The upshot? Not a pretty picture.

Broadly defined, the spread of bad financial news, like a transmitted disease, moves quickly, has the potential to wreak havoc and is hard to contain once unleashed. This is why policy-makers worry about anything that can accelerate diminished investor confidence and panic market participants into selling off positions they would otherwise choose to hold.

Contagion itself is dangerous but when you consider what some describe as an inevitable convergence towards one global market, with trading that occurs 24/7, the potential for serious harm is real. Continued technological advances, international deregulation and investors' willingness to go offshore promote lightening speed information flow. When bad news hits, it's the shot heard 'round the world. Having worked on three trading desks during volatile times, I know firsthand how quickly things can change.

Taking a page from science, the "butterfly effect" describes how tiny changes can lead to large-scale disturbances. Click here to read about meteorologist Edward Lorenz and his seminal work in chaos theory. Does his notion that the flap of a butterfly's wings in Brazil can set off a Tornado in Texas apply to pensions?

Let's consider some facts.

1. The graying of the global population is real.

2. Life expectancies are climbing in the U.S. and in most developed countries.

3. Countless U.S. and non U.S. government plans are hamstrung by reluctant taxpayers, binding labor contracts and defined benefit plans with fixed terms.

4. Regulatory reform here and abroad has accelerated the need for liquidity.

5. Companies around the world rely on higher return (read higher risk) investments to close the pension gap.

6. Shareholders in U.S. companies are preparing for the worst with the first batch of annual reports that reflect FAS 158 compliance, similar to the FRS 17 effect in the UK. GASB 45 is keeping public plan leaders up at night.

7. Many companies outsource or have global staffs with benefits offered to all.

8. Different country governments and multinational companies alike invest in each other's securities.

Market returns are correlated. Labor mobility exists. Companies buy and sell around the world. News travels fast.

What does that infer? Pension contagion is a real possibility.

Editor's Note:

The World Bank website links to some research papers about financial contagion that may be of interest.