“Five years ago this fall, an epidemic of fraud and thievery in the financial-services industry triggered the collapse of our economy,” writes Rolling Stone’s Matt Taibbi. “Today, the same Wall Street crowd that caused the crash is not merely rolling in money again but aggressively counterattacking on the public-relations front. The battle increasingly centers around public funds like state and municipal pensions.”
State and local governments were hit hard in the crash as tax revenues dwindled. At the same time, public pension funds across the United States had been heavily invested in Wall Street’s AAA-rated “toxic securities,” and when the house of cards fell it left significant gaps in their funding.
But Wall Street would not be shamed for the economic pain it had inflicted. At the same time as leading hedge funds financed a campaign advocating cuts to the benefits retirees expected to receive, they lobbied lawmakers to relax the rules governing pension fund investments so that they could siphon off a chunk of the $2.6 trillion that remains under public pension funds’ management.
And, as Taibbi writes…
This war isn’t just about money. Crucially, in ways invisible to most Americans, it’s also about blame. In state after state, politicians are… using scare tactics and lavishly funded PR campaigns to cast teachers, firefighters and cops – not bankers – as the budget-devouring boogeymen responsible for the mounting fiscal problems of America’s states and cities.
Moyers & Company’s Joshua Holland caught up with Matt Taibbi last week to discuss this vexing story. Below is a lightly edited transcript of our conversation.
Joshua Holland: Matt, this is a maddening piece. I am going to bill you for my blood pressure medication. I mean you better hope that Obamacare gets implemented.
What I find truly outrageous about this is that we’re in the midst of an awful retirement crisis. Teresa Ghilarducci — she’s a professor of economics at the New School for Social Research — she says that in 2010, 75 percent of Americans who were nearing retirement age had less than $30,000 in their retirement accounts.
Matt Taibbi: Right.
Holland: And she says that almost half of all middle-class workers — 49 percent — will be poor or near poor in retirement, living on a food budget of about $5 dollars a day.
A big part of this has been driven by the shift from traditional defined benefit pensions to 401(k)s. Among the very few people who still have traditional pensions are public sector workers, and here we have these Wall Street hustlers basically coming in and trying to loot their retirement savings.
Matt, a lot of states and localities do have big gaps in their pension funding. Let me start by asking you, whose fault is that?
Taibbi: Well, there are primarily two reasons why most states’ pension funds are depleted. One huge reason is that a lot of states and municipalities have not been making their required contributions into the funds every year. They’re mandated by law to throw in a little bit of money. Most of the funds are actually funded by the workers themselves — they make a small percentage contribution of their incomes into the funds – but there’s also a taxpayer contribution, and the states were supposed to have put that money in for years and years and years. What they’ve been doing, in many cases, is just not doing that. Politicians have been taking that money and spending it on other stuff — building things, stadiums, swimming pools, new athletic complexes, giving out tax breaks to influential donors, things like that. So that’s one problem.
The other huge problem is that a lot of pension funds were targeted as institutional investors by financial companies and banks in the pre-crash years and they bought mortgage-backed securities, which subsequently blew up. So they were buying a fraudulent product, which ended up depleting the fund.
Holland: And this is one of the key issues: the rating agencies were in cahoots with Wall Street, and they would bless these piles of toxic securities as triple-A rated securities. A lot of pension funds are required to invest only in highly rated investments. So they were basically cooking the books so that pensions could buy into this junk.
It blew up in their face, and now we have this so-called pension crisis, and it seems that there’s a push to run in there and loot it. And it strikes me, reading your piece, that there’s kind of a confluence of ideology and greed going on here. For some time, the right has been making public sector workers into the new welfare queens, living large off the public teat — never mind that, according to economist Dean Baker, the average public employee’s pension was just $22,000 dollars in 2007, and a lot of them aren’t even eligible for Social Security.
So there’s that ideological component, and then there’s a kind of shock doctrine going on, where we have this contrived crisis and then these sharks just move right in to feed.
How extensive is this campaign to convince the public that bloated public employee pensions are to blame for the budget crunch that these states and localities are dealing with?
Taibbi: Well, there are organized campaigns going on in almost every state in the country. There are foundations like the Arnold Foundation, which is run by a former Enron commodities trader and billionaire named John Arnold. He’s sort of the Koch brothers figure in this tableau. The Pew Charitable Trusts have a partnership with the Arnold Foundation. The Manhattan Institute — which is kind of a finance sector think tank — they’ve done a lot of work on this stuff. Students First New York is another group that has been campaigning against defined benefit plans.
Almost every state you go to, there’s some kind of organized campaign that essentially says, states are broke, the reason is that these benefits are unsustainably high, and the solution is a combination of cuts going forward and then a move toward sort of a 401(k)-style plan that includes — and this is really the important part — that includes investing a large parcel of this public money in “alternative investments,” which ends up putting the money right back into the hands of Wall Street.
Holland: Tell us a little bit more about that angle. Aren’t hedge funds supposed to just outperform the world?
Taibbi: [laughs] No. In fact, even BusinessWeek just had a great cover called “The Hedge Fund Myth.” I can’t even describe the cover because it’s too off color, but essentially, what people are coming around to is that hedge funds don’t outperform the market over time. And one of the sources I talked to for this story summed this up for me the best. He’s the guy who manages public monies in the State of Illinois, and he was saying essentially, ‘look, the real question is how much inefficiency is there in the market to be taken advantage of? If you believe that there’s a lot, then that’s a good reason to go with hedge funds. If you believe that there’s a lot of money to be made not just by putting your money in a broad index investment, then, yeah, you’d want to put some money in a hedge fund.’
“Warren Buffet had bet against a hedge fund in New York five years ago that a random bet on the S&P would outperform hedge funds, and five years later he’s winning by nine points.”
But remember, when you invest in a hedge fund, that hedge fund has to do essentially three to four percent better than an ordinary index fund just to get back to even, because it costs that much more to invest with a hedge fund. So you can invest in a standard index fund for like 1/100th of a percent, whereas it costs sometimes 2 percent or even 3 percent to invest with a hedge fund, so you’re talking 200, 300 times the cost. So that’s really the question.
And of course, famously right now, Warren Buffet had bet against a hedge fund in New York five years ago that a random bet on the S&P would outperform hedge funds, and five years later he’s winning by nine points. So, you know, there’s your answer right there.
Holland: And it’s not just the 2 percent fees to get in. They also take a big chunk on the way out, in terms of profits. It was when I was writing about Bain during the last election that I learned about these ‘2 and 20’ arrangements.
These funds are charging exorbitant fees while we’re pushing these deep cuts on public sector workers who put their entire careers into serving their communities and end up with relatively modest pensions. I mean, you hear anecdotally of some sheriff with a $300,000 dollar pension, but again, the average is $22,000 dollars.
Matt, why do they keep it secret? Why can’t these workers find out where their money is invested?
Taibbi: Well, I think there are two reasons. Number one, if they knew what the fees were, I think people would be out in the streets, because it’s even worse than what you say. You know, the standard formula is two and 20 – you get two percent just for showing up, so if you put $100 million into a hedge fund, [the fund] gets $2 million dollars right away, before it even performs. Then it gets 20 percent of all the profits.
Then there’s a thing called “fund expenses,” which is typically half of a percent and can cover just about anything, travel expenses for the people running the fund, dinners, whatever. Then there are trading costs, which typically add up to another percent or more, so every time the hedge fund trades it pulls those fees out — it doesn’t actually show up as a line item. It just shows up as less money in the fund later on.
And then the final thing is, if you want to withdraw money, if you want to redeem your funds, you have to pay a fee for that.
So there are five different fees that you’re paying for that kind of alternative investment, and that ends up to being three, four, even five percent that you’re going to pay, which, again, might be 500 times what you’d pay for a typical S&P index fund.
And then the other question is what are they invested in? In a lot of cases you don’t know, but it could be something horrible. I mean we’ve had ridiculous examples. We’ve had workers compensation founds that have turned out to be invested in Beanie Babies and rare coins. We’ve had people who were invested in payday lenders. There are other funds that are invested in factories overseas, so you’re a worker here at home, you’re a union worker, but you’re funding the construction of a Chinese factory. You know, all kinds of horrible stuff, and I think union workers have a right to know what’s being done with their money.
Holland: Yeah, I agree with everything you write, but I think Beanie Babies are a really solid investment, actually. [Laughs]
Matt, if I bring a bagful of $50 dollar bills to a pension administrator and I say, “I’ll slip you this bag of cash under the table if you invest with my hedge fund,” I feel like I’d end up in jail. What’s a placement agent?
Taibbi: A placement agent is a guy who gets paid — it’s an amazing phenomenon — essentially, he gets paid to introduce pension boards to alternative investors. So it’s just a middleman. Typically, it’s a former member of a board. He might, for instance, have formerly served on the board of something like CalPERS or CalSTRS in California. And he gets paid a gigantic fee, that sometimes can be millions of dollars, just to introduce the board to what he believes is an attractive hedge fund.
What’s so interesting about this is that in some cases there are restrictions on how much this placement agent can be paid by the pension fund, but there are no restrictions on how much he can be paid by the hedge fund. So he might be getting paid both coming and going, by the state — by the pension fund — and by the hedge fund they end up hiring. So this is just a middleman who sits in between and is essentially legally collecting money as part of a kickback scheme. And this goes on all over the country and it’s legal, and it’s another thing that eats into the pension fund costs, and it’s another reason why people have to tighten their belts and take lower benefits.
Holland: Who is Gina Raimondo?
Taibbi: Gina Raimondo is the treasurer of the State of Rhode Island. She’s a Democrat. She’s thinking of running for governor. She pushed through a model pension reform plan in her state. When I say a model plan, it’s a plan that was advocated for by groups like the Manhattan Institute, you know, these Wall Street-friendly groups. There was a group in Rhode Island called Engage Rhode Island, which turned out to have taken a lot of money from the aforementioned John Arnold, the Enron guy. And she crafted a pension reform plan that kind of fit the parameters of what Wall Street wants to do with public pensions.
They hybridized the plan and turned part of it into a 401(k) type of plan, and then she went from having zero percent of the fund invested in hedge funds to having over 15 percent of the fund invested in hedge funds.
And just a couple of days ago she announced that they’re going to be paying $70 million dollars in fees for alternative investments just for last year, which roughly matches the amount of money that they’re going to save by asking workers to freeze their cost of living adjustments. So this is sort of a microcosm of what’s going on all over the country. Workers are being asked to take cuts, but those savings are being plunged right back into hiring hedge funds. And she’s in the middle of that.
Holland: Now, here’s something that I just don’t understand. These pensions are the result of negotiations with the unions, right? I mean they’re contractual obligations.
Taibbi: Right.
Holland: Let me quote briefly from the United States Constitution. I hear conservatives talking a lot about this document — I hear it’s a good thing.
Article I, Section 10 contains what’s known as the Contract Clause, and it reads, in part: “No state shall…pass any Bill of Attainder, ex post facto Law, or Law impairing Obligation of Contracts.”
It’s really simple. It seems pretty straightforward. How is that working out? I mean how are they getting away with this?
Taibbi: In Rhode Island there was a group that went on a roadshow to push the pension reform plan that Raimondo and some other people had cooked up, and they had a PowerPoint presentation, and one of the parts of the presentation involved potential objections to this plan. And on one of the slides it notes that, ‘The US Constitution forbids the abrogation of contracts; the Rhode Island State Constitution also forbids it. So you might get that objection when you’re pushing this…’ [laughter] So even those people were aware of it. But they went ahead anyway, and, that’s what’s going on.
That was part of what happened in Rhode Island that was different. Initially, before the courts forced them to go back and negotiate the new pension reform, the pension reform in that state was done unilaterally, without going back to the unions and re-bargaining the contracts, which you would think is unconstitutional, but that’s exactly what happened. And that’s what they want states to have the power to do now is just to go back and change these arrangements that might have been made 15 or 20 or 30 years ago.
Holland: And that’s certainly what they did in Detroit, where the emergency manager unilaterally — they didn’t go back and renegotiate contracts — they unilaterally cut benefits.
Taibbi: Right. Exactly.
Holland: So what about the effort to push back on this? Is there a campaign to right this wrong? What’s going on on that front?
Taibbi: Yes, there definitely is. I think unions everywhere are only beginning to catch on to the intricacies of what goes on with pension finance. You know, it’s funny, one of the union workers I talked to, he was kind of laughingly comparing being at a pension board meeting to watching the movie Windtalkers. He said, “You can sit and listen to these guys for a half an hour and you won’t have any idea what the hell they’re talking about.” And this is a huge obstacle because there’s no rule in most states that the people who sit on pension boards have to have any background in finance, and yet, this kind of finance is about as complicated as it gets. I mean if you’re just a layman sitting there, you won’t have any idea what anybody’s talking about, and if you’re looking at these spreadsheets, you won’t have any idea what the fees are. So they’ve had to get up to speed.
I think union reps now realize that they have to educate themselves about how all this stuff works, and they’re starting to push back and they’re starting to demand answers. And we’ve seen the results in places like Rhode Island, where initially they didn’t disclose anything about fees, but now they’re getting that information. And initially they didn’t even consider the issue of hiring hedge funds that had taken anti-labor positions, but they’re considering it now. So there is some movement on it, but the problem is that there’s just so much more money on the other side.
Holland: That’s the story of our time in so many ways.
Leslye Davis/The New York TimesJPMorgan Chase’s earnings were eroded, in large part, by a legal expense of $9.2 billion.
Document: News release
