I find it ironic that the next financial bubble to burst may be the lucrative defined benefit plans for unionized state and local employees. In the 1980’s after we had recovered from our last major bout with inflation and stocks became a viable investment option again, most businesses converted from defined benefit plans to defined contribution plans. It was a case where the scandals and mistakes concerning defined benefit plans made them very unattractive compared to defined contribution plans. Several of the defined benefit plans were seriously underfunded and there was was little oversight on how fund managers invested. Since I was alive at the time I can say that the average person was pretty sure they could get a better return on their pension using a stock index fund than these fund managers. Another widely held view was that the defined benefit plans of the steel and auto workers were a major cause leading to the demise of those industries. Businesses did not need the distraction that comes with mismanaged pension funds. Defined contribution plans promised financial responsibility by both the companies and the employees. It was a simple choice for businesses but defined contribution plans were the lesser of the two evils.

State and local employees chose to ignore the history surrounding defined benefit plans in return for promises of lucrative benefits. Now we appear to be entering an economic environment in which we will see low return on investments, increasing unemployment, and increasing inflation. This implies that state and local governments will either commit large amounts of their operating budget to fund pension benefits or to cut pension benefits. This is very similar to the situation we saw in the 1970’s in which defined benefit plans ate up operating budgets. Wow! Déjà Vu all over again!

Okay, I know it is easy to be critical of the mistakes made local and state governments. Here is my contribution to improving the situation. How about a federally insured pension benefit corporation to take over the underwater pension funds? Naturally it would have to extract some fiscal responsibility from the participants. I suspect that over the next couple of years the government pension benefits will be rationalized downward to what we may call a national standard. If the pension benefits can be viewed like an employer paid payroll tax we may get better fiscal responsibility by unions and governments. My view is that the pension benefit corporation would not need federal funding but would be able to borrow funds at federal rates. This may be useful as state and local governments make the transition from a seriously unfunded pension liability to solvency. Now if we can get this corporation to invest in treasury inflation protected securities we might have an efficient, workable pension system with low investment risk.

Zelinsky: Obama Embraces Defined Contribution Paradigm
Paul Caron
Sat, 11 Apr 2009 10:00:00 GMT