Rauh Testimony (2) Loan Program

Joshua Rauh’s written testimony to the Joint Select Committee on the Solvency of Multiemployer Pension Plans (Bailout Committee) included this warning:

Most of the justifications of a loan program to rescue the multiemployer system are built on the false logic that plans can get something for free if they receive low-cost subsidized government loans and invest the money in risky assets.

However this is not how the loan program is going to work according to Representative Richard Neal (D-MA):


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Rauh puts forth a solid argument on why the rationale behind Pension Obligation Bonds is flawed (full text below*) but that is not what I (and Representative Neal) see happening here.

The worst funded multiemployer plans (who presumably will be the ones getting the ‘loans’) are going to need that money to pay their retirees with little room for arbitrage. Otherwise the government might as well provide loans to well funded multiemployer plans (assuming such an animal exists) so that they can cash in on their investing acumen. What this program will devolve into is a steady income stream for Manulife (and any other company willing to sign on) backed by the full faith and credit of US taxpayers.

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* VI. Loan Programs and Pension Math
Several proposals have been made to create loan programs for multiemployer plans. Notably, S.2147 (Butch Lewis Act of 2017) would “amend the Internal Revenue Code of 1986 to create a Pension Rehabilitation Trust Fund, to establish a Pension Rehabilitation Administration within the Department of the Treasury to make loans to multiemployer defined benefit plans,” and S.1911 (American Miners Pension Act of 2017) would “transfer certain funds [from the Abandoned Mine Reclamation Fund] and provide loans to the 1974 United Mine Workers of America (UMWA) Pension Plan in order to provide pension benefits for retired coal miners.”
The logic behind a loan program is generally based on the same fallacies that underlie the measurement of pension obligations using expected return on assets. The proposals are often sold as a win for taxpayers under the idea that the plan will pay a low fixed rate of interest to the federal government, and then invest the proceeds in its portfolio of risk assets which it hopes will earn the actuarial expected rate of return. But if this were clearly a good policy, then voters would want to urge the federal government to borrow far greater amounts of money and invest it in the stock market on its own behalf.
For example, consider the federal government’s projected budget deficit for the current fiscal year. The CBO has projected an $804 billion budget deficit for Fiscal Year 2018. Federal budget deficits generally must be covered through additional borrowing. So an FY18 budget deficit of $804 billion would add $804 billion to the federal debt until the time that it could be paid back. Without a plan to pay it back, that addition to the federal debt would be assumed to be indefinite, and would certainly appear on the horizon of a standard 10-year budget window.
According to the same flawed logic behind the loan program, however, the Federal government could solve its problem of creating debt over a 10-year budget window in the following way. Instead of borrowing just $804 billion today, it could borrow $1.608 trillion today (twice the budget deficit) from taxpayers. Of the $1.608 trillion it borrowed, half of that ($804 billion) could go to pay for the unfunded expenditures this year, and the other half ($804 billion) could be invested in a portfolio of assets similar to that of a pension fund.
If these funds are assumed to have a return of 7.2% per year, the entire $1.608 trillion could be assumed to be paid off in 10 years, as the $804 billion growing at 7.2% per year would double in 10 years, appearing to eliminate the debt. Of course, the federal government would have to pay around 3% annual interest on the borrowing, so this program would cost $24.1 billion per year over each of the next 10 years– but that $241 billion spread over 10 years would be a comparatively small price to pay for apparently “eliminating” an $804 billion current budget deficit. The government would essentially be assuming that it could book as profit the spread between the 3% borrowing rate and the 7.2% investment return.
Furthermore, the problem of the interest costs could be “solved” by investing more aggressively. Many institutional investors have return targets of 8% or even more. If the government could assume an 8.9% rate of return, the $804 billion portfolio would grow enough to pay off the $1.608 trillion borrowing plus all accrued interest at the end of the 10 years. Assuming the 2.9% June 2018 year-on-year CPI-U inflation rate persists for 10 years, this assumption could be disclosed as a “real return assumption” of just 6%. By borrowing more than necessary to fund the deficit and investing the balance in risky assets that itassumes will earn high enough returns to repay all the debt, the federal government could assume its budget deficit away.
The clear flaw in this logic is that it ignores the risk that the asset pool will not achieve the expected return. Loans to multiemployer plans, which those plans would then invest in portfolios of assets, are analogous. The fact that the federal government would not under take such transactions on its own account reflects that fact that it would be concerned about the inherent risk in doing so. By loaning money to the multiemployer plans to invest in their portfolios, the federal government would be acting in a way similar to the buyers of pension obligation bonds (POBs) issued by some state and local governments. The federal government would thus be placing taxpayer money at risk if the loans were not able to be repaid in full due to investment returns that fall short of the target.

7 responses to this post.

  1. Posted by Anonymous on August 2, 2018 at 10:45 am

    Thanks for clearing up the mud from Rauh. Your analysis is exactly right. I think we can address the desire to invest more aggressively ( 8%) by limiting the level of risk. Using your example ( and I realize that you used rule of 72 for convenience ) . A fund could invest at a lower return of 5-6% which is less risk and still earn a reasonable spread, Of course there is risk and that should be discussed.
    your idea of the treasury borrowing at 3% and then investing has some level of attraction and lots of concerns.

    Reply

  2. Posted by Tough Love on August 2, 2018 at 2:34 pm

    You are right, which is WHY the Taxpayers should have NOTHING to do with this loan/bailout..

    And that Neil guy with his pointy fingers ……….. reminds me of Gov Murphy, give me a barf-bowl.

    Reply

  3. Most of the justifications of a loan program to rescue the multiemployer system are built on the false logic that plans can get something for free if they receive low-cost subsidized government loans and invest the money in risky assets.

    Nailed it. Even a 9th grader with basic (even limited) math and financial knowledge know this is a straight up fraud. It is not a “loan” at all, it is a gift of public $$ to the failed pension plans backstopped by the US taxpayers, most of whom are in much worse conditions. It is morally and ethically a fraud and scam, and a shameful attack on the poor and middle class who will pay heavily to fund this fraud through regressive taxes.

    Reply

  4. Posted by Harry Chernoff on August 3, 2018 at 3:59 pm

    John:

    What Rep. Neal and you see happening is worse than what Prof. Rauh describes. Rauh is describing a fictional risk-free arb opportunity at the expense of the US taxpayers. What Neal is describing is an open-ended moral hazard opportunity on top of the fictional risk-free arb opportunity.

    The optimizing strategy for any pension fund eligible for Neal’s plan now or in the future (including plans created from scratch to take advantage of this opportunity) is to maximize the distribution of the plan assets (e.g., a 13th month distribution, pension spiking, increased survivor benefits, increased COLAs, etc.) while simultaneously minimizing plan contributions and maximizing the assumed actuarial return on the asset balance. The objective is to maximize the deficiency that is backstopped by the fictional risk-free arb opportunity at the expense of the US taxpayers.

    This makes sense how, exactly?

    Reply

    • Posted by Tough Love on August 3, 2018 at 4:10 pm

      Well stated !

      Reply

    • I see Neal’s plan happening since nothing else is out there but as Sting said:

      I never saw no miracle of science
      That didn’t go from a blessing to a curse
      I never saw no military solution
      That didn’t always end up as something worse

      I would make that ‘government’ solution and apply it to what they are going to do. Retirees will get paid more than they would under current PBGC rules. Unions, actuaries, and investment people will keep making a living off these zombie plans. And now insurance companies will make some money too. All backstopped by taxpayers. What would have cost about $100 billion in a PBGC bailout will spike to maybe $500 billion with all these vultures feeding off the carcass of a rotting multiemployer system.

      Reply

      • Posted by Tough Love on August 3, 2018 at 6:11 pm

        Quoting …………..

        “What would have cost about $100 billion in a PBGC bailout will spike to maybe $500 billion with all these vultures feeding off the carcass of a rotting multiemployer system.”

        Yea …………. and that’s BAD, not “necessary”, and certainly shouldn’t be paid-for by Taxpayers who had ZERO to do with MEP Plans.

        Reply

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