Election won't prevent pension crash

By Amity Schlaes
The Orange County Register
http://www.ocregister.com
September 29, 2012

It's a taxpayer divide. That's the takeaway since the videotape was leaked of Mitt Romney referring to the 47 percent of citizens who don't pay income taxes.

The Republican presidential nominee described a large political gap between those who pay the tax and those who don't, and those who wouldn't vote for him, "no matter what." This line was perceived as cold, and his campaign has been apologizing ever since.

But the fuss obscures a reality. The tax gap isn't the deepest divide in America. The deepest gap is the pension divide, between those few who have a guaranteed cushion in the form of defined-benefit pensions, which promise a fixed annuity at retirement, and those who don't. How the candidates address this divide, cultural as well as political, is crucial, far beyond November.

To understand the current mindset, it helps to consider the pension culture of the past. In the early 1980s, many companies, as well as governments, offered employees a defined-pension benefit when they retired. Thirty years ago, about 62 percent of American workers were covered by some kind of plan like this.

Even then, however, companies routinely siphoned off the funds' surpluses for purposes other than pensions. Pension returns themselves looked modest relative to the incredible interest rates offered in the money market. But federal law prevented workers in private plans from pouring their pension money into tax-deferred vehicles. A defined-benefit pension felt like a prison.

The power of this sentiment becomes clear when you recall what happened in January 1982, when lawmakers opened what seemed, at the time, a small window in that prison. The law changed so that private-pension employees might place cash in tax-deferred vehicles for retirement.

"A barrage of advertisements is stirring public interest in the new program of tax-deferred retirement plans, known as the individual retirement accounts, or IRAs," wrote New York Times reporter Karen Arenson. Brokerage houses couldn't answer the phones fast enough. One firm, T. Rowe Price Group Inc. of Baltimore, reported receiving 1,500 inquiries a day.

In short, Americans busted right through that prison window and made it a big door to a new heaven, that of defined-contribution pensions that you managed yourself. In January 1982, the 18-month fixed rate at Chemical Bank was 14.25 percent on a minimum investment of $250. Even teachers could get in on the bargain. At the Nassau Educators Federal Credit Union, the variable rate was 15 percent, with no minimum investment. It was no surprise that 401(k) plans and IRAs grew quickly. "Heck, we are just diversifying," the new investors told themselves. After all, they did have a fallback: the sure annuity of Social Security.

Of course, some people chose jobs with old-fashioned annuity pensions, such as teacher or fire fighter. But the defined-contribution crowd took the steady-as-you-go crowd for fools. For many years, market circumstances conspired to support their assumption. Money rates were never as high again. As it happened, 1982 also marked the beginning of the great stock-market rally, and the defined-contribution crowd eventually shifted blithely to equities.

Over time, companies got out of the defined-benefit model, and the truism that it was for government employees became true. By 2009, the last year for which data are available, only 16 percent of private-sector workers were active participants in defined-benefit plans, compared with 74 percent of public-sector workers, according to Sylvester Schieber, the author of "The Predictable Surprise," a recent book on pensions.

Today, it is the teachers who laugh and the defined-contribution crowd who feel like fools or prisoners. The high interest rates that made IRAs sizzle in the early 1980s are gone.

The snapshot stock returns that brokers and indexes get often elude individuals. Current public employees seem fairly confident they will receive those pensions, and that confidence is not lost on the rest of a shaken electorate. Everyone else covets what those police officers have. The pension check that government staffers will get is all the more attractive because Social Security, the one fallback for those without a defined-benefit plan, is expected to suffer a shortfall of trillions.

The great perversity here is that the promises of the defined-benefit plans from states and towns aren't part of the market economy. In 2010, the gap between state assets and what they owed in pensions was $757 billion. The public-pension funds can bet on high-risk investments, because if the gamble pays off, great, but if it bombs, the taxpayer – who has no defined-benefit plan – has to make up the difference anyway.

Meanwhile, Illinois has floated bonds to pay its pensions, which Schieber likens to "using your credit card to pay your mortgage."

Yet the darker the future, the stronger the denial. For all these reasons, the tension between defined-benefit folks and everyone else only grows. The IRA and 401(k) people are talking breakup, as in the Taylor Swift song: "We are never ever ever getting back together." They are angry because they believe the public-sector unions have it too easy.

The reality is that a big public-pension crash, which eventually will occur no matter who wins the election, will make clear that the government employees won't get what is promised. It will reveal the truth: We are all in the same boat fiscally and even financially. President Barack Obama's strategy is to keep up the denial until Election Day. The main hope Romney has is to showcase this reality before the election. Of course, he can't do that, if he is too busy apologizing.