As a result of the landmark 1994 Congressional election, the taxpayer revolt, and the realization that the federal government must balance its budget, the usual Democratic solution of raising taxes and increased social spending is no longer an option. The Clinton Administration has launched a behind the scenes, incremental strategy to fund its social agenda by tapping into the $3.5 trillion private pension system.
The Clinton Administration euphemistically refers to its plan as "economically targeted investments." In reality, this is another phrase for social investing, the now discredited practice of making investments that provide lower returns in order to achieve some social or political goal. These goals may include any number of social issues in the Clinton agenda that can no longer receive funds through increased taxes or more traditional forms of financing.
For more information regarding this issue, please call Joe Engelhard at 202-226-3229.
The "Clinton Pension Grab" represents the near success of one of the more ambitious plans to conscript millions of Americans' pension fund assets in the service of the Clinton agenda. It also reflects the determined efforts by the Center for Policy Alternatives and the more liberal advisors in the Clinton Administration to give the federal government a foothold in the private pension system which represents over one-fifth of the nation's assets.[1] According to a March 1994 Business Week report, the Clinton Administration "is making a major push to steer more of the [$3.5] trillion in private pension funds into inner cities, minority-owned businesses, road and bridge projects, and companies that train their workers." In the same article, Olena Berg, Clinton's top pension regulator, admitted the ambitious nature of this project saying, "It's a radical notion."
This radical notion would apply to the $3.5 trillion dollars in private pension assets, the single largest pool of private assets, and would affect a larger portion of the economy than government spending on health care. With one-fifth of all financial assets in the United States now belonging to pension funds, the Clinton Pension Grab would put at risk of government direction the largest sector of our economy since the failed Clinton health care "reform" plan.
Those in the Clinton Administration who believe that government and increased federal social spending provide the solution for every problem have seized on American workers' pension wealth as the solution to a serious dilemma. The liberal solution which calls for massive federal spending has resulted in huge budget deficits and the highest overall federal debt in America's history. For years, the traditional Democrat solution for federal deficits has been to increase taxes. But faced with an angry electorate that revolted against constant increases in taxes and the need to balance the budget, the social planners in the Clinton Administration had to look to a new source of financing for their social spending projects.
Following the lead of such liberal thinkers such as Lawrence Litvak and Derek Shearer, Robert Reich, President Clinton's Secretary of Labor, has become the champion of this self-described "radical notion" to use the massive $3.5 trillion "honey pot" of wealth in the private pension retirement system as a new source to finance the liberals' federal spending solutions. Accordingly, once this vast reservoir of money is tapped, ample funding will be available for the various federal spending projects that were threatened by the taxpayer revolt. What this viewpoint overlooks, however, is that the private pension funds belong to the individual pension beneficiaries, not to the federal government.
Bill Clinton's presidential campaign first brought ETIs to the national spotlight. The Clinton campaign document, "Putting People First," later published as a book under the same title, included an ambitious plan calling for an $80 billion dollar federal investment in a variety of infrastructure developments leveraged with public and private pension funds.[2] As unusual as this proposed use of future pension beneficiaries' income was, it was not the first time that then Governor Clinton had found innovative uses for pension fund investments.
In 1985, as Governor of Arkansas, Clinton pushed for and obtained passage of state legislation that directed the Arkansas public pension fund system to target five to ten percent of its investment portfolio towards a variety of social goals in the state of Arkansas. For instance, when the Kappa Kappa Gamma Sorority needed a loan for a new residence, Governor Clinton prevailed on the state's pension, the Arkansas Teachers Retirement System (ATRS) to finance the sorority's mortgage loan. When questioned about this, Bill Shiron, the ATRS pension fund manager replied: "I know the daddies of those girls, and there is no way they would have allowed that loan to go bad."[3] Funds from the ATRS's $3 billion pension fund also were made available to the Arkansas Development Finance Authority, which has been attacked by critics as a mechanism to line the pockets of then Governor Clinton's supporters such as the Stephens family and the Rose law firm.[4]
As soon as Clinton's post-election "economic summit" in Little Rock was announced after his election, numerous interested parties and Clinton's advisors began devising a behind the scenes, incremental strategy using executive actions and administrative rulings to accomplish Clinton's pension grab. Public policy groups such as the Center for Policy Alternatives urged lowering pension investment standards to include "collateral" social benefits, and Pension & Investments magazine reported that pension investors were already being pressured to make targeted investments.[5] David Vienna, the head of an Alexandria, Va. based public affairs consulting firm that represented the $ 70 billion California Pubic Employees' Retirement System, was quoted in the same article as saying, "Pressure is being placed by politicians on trustees to at least encourage, if not compel, them to make investments they ordinarily would not make as fiduciaries."
The pension community resisted the Clinton campaign strategy, however, and Gina Mitchell, manager of government relations for the Financial Executives Institute, said at that time: ''We don't want anything that would subordinate or mandate pension fund investments.''[6] At the Economic Summit one of the most important moments was Alicia Munnell's presentation on implementing the campaigns infrastructure plans, and Clinton was encouraged to expand the meaning of "infrastructure" to include a wide range of special interests.[7] Without abandoning their overall strategy set out in the campaign, the next stage in Clinton's great pension grab came last June when Labor Secretary Robert Reich issued Interpretive Bulletin #94-1 (IB 94-1). This bulletin defined ETIs in a way designed to make them seem consistent with the Employee Retirement Income Security Act (ERISA), the federal law that protects private pension fund beneficiaries.
In the fall of 1994 the Clinton pension fund grab reached a new stage with the establishment of a clearinghouse intended to showcase ETIs and give them the federal government's good-housekeeping seal of approval. The Clinton Labor Department awarded a contract to Hamilton Securities, at a cost to the taxpayer of over a million dollars, to establish an ETI Clearinghouse that would include all of the "socially desirable" investments that should be funded by future pension retirees and beneficiaries.
Many experts believe the final stage and the ultimate objective of the Clinton Administration is to implement a five to ten percent quota on private pension funds. This will only be possible after ETIs have become a common, accepted part of pension investing, as has already happened to a great extent in the local and state pension system. According to a study by Cassandra Moore for the Cato Institute, more than 18 states have introduced legislation that would mandate ETI quotas. A typical example is the California bill introduced in February of 1995, proposing an ETI quota for investment in low income housing.[8]
Clinton's political advisors, aware of the potential public relations disaster if retirees became aware of the social and political use of their pension benefits, were careful to avoid any reference to exactly how working Americans' pension funds were to be used to promote social and political goals. To make it even harder for average workers to realize exactly what was happening to their pension "nest eggs," Robert Reich latched onto the euphemistic phrase, "economically targeted investment." This reasonable sounding term would disguise from the American worker the fact that his or her future retirement income was being put to political uses with which they may not agree.
Despite all of the effort by the Clinton Administration to promote ETIs, it is troubling that they cannot give a clear explanation of what an ETI is. This is because the essential characteristic of an ETI has nothing to do with the traditional pension fund investment strategy of maximizing risk-adjusted return for the pension's beneficiaries. ETIs add a second goal which is a non-economic one of a social or political nature, and may include the desire to create low-income public housing, to provide more union jobs, to fill capital gaps, or to forward the investor's socio-political agenda.
The efforts of President Clinton's Secretary of Housing, Henry Cisneros, to use private pension funds to finance low income housing provides an example of the social goals involved in ETIs. When questioned about this unusual use of private pension funds, Secretary Cisneros reassured pension managers, "We're not launching a raid on pension funds."[9] In the very next breath, however, Mr. Cisneros said, "We are trying to build bridges between fund assets and affordable housing." The Housing Secretary's statement did not focus on the economic risks inherent in these investments, but rather on his perception of a social good to be gained from "building bridges" between American's future retirement benefits and risky low income housing projects.
Because ETIs add this second goal, they are best described as social or political in nature. It is deceptive to call such investments that aim at low income housing or union job creation as economically targeted, because such investments are more precisely being made for social and political purposes rather than maximizing risk adjusted economic return. Investing in a public housing project in the Bronx rather than a traditional investment in high-tech stock such as Microsoft is hardly what you would call an "economically targeted" investment.
That is why Jim Saxton, Vice-Chairman of the Joint Economic Committee, prefers the label "politically targeted investments" or PTIs. One may agree or disagree with the relative merits of such investments, but at least calling them politically targeted investments accurately describes their true nature. The ultimate problem, and one that the Clinton Administration has failed to recognize, is that the money being invested belongs not to the federal government, but to the millions of hard working Americans who struggle to save as much as they can for their retirement. Regardless of what name is used to describe such targeted investments, however, once one goes beyond their social/political nature and examine their economic and legal aspects, it becomes clear that ETIs represent a potential threat to the pension system and to the federal projections enacted into law to ensure the security of American worker's future retirement benefits.
Some of the economic difficulties with ETIS are admitted even by the promoters of these investments. The Department of Labor (DOL) itself has admitted, "ETIs are less liquid, require more expertise to evaluate, and require a longer time to generate significant investment returns."[10] ETIs are often ill-liquid because ETIs in many cases involve investments that are relatively new with little or no track record, and often are unique or unusual investments that do not fit readily into a pension portfolio. Furthermore, if a pension investor were to take seriously the goal of creating ancillary benefits, this would require additional investigation and analysis, which would result in higher administrative costs. Lastly, it would take longer to generate any significant investment returns in the many cases of ETIs that are brand new opportunities that will take a long time to realize any profit.
What the Labor Department does not say, but what naturally follows from admitting ETIs are less liquid, require greater expertise, and take longer to produce profits, is their tendency for greater risk and lower average returns compared to traditional pension investments.
Critics of ETIs argue that by adding a second goal there is an additional burden placed on pension investors that will result in time and effort being diverted from the goal of maximizing risk-adjusted return on pension investments. By increasing risk and lowering returns for pension investments, the Clinton strategy places the $3.5 trillion dollars of private pension funds at risk. The experience of several state pensions -- which are not subject to the fiduciary duties in ERISA -- clearly demonstrates that investing in ETIs often results in the losses totaling hundreds of millions of dollars.
The Kansas Public Employee Retirement System (KPERS) has lost over $390 million dollars due to ETIs made in the 1980s.[11] KPERS' experiment with ETIs also resulted in over ten lawsuits, with the pension advisors and their attorneys being sued for personal liability. In one investment alone, the Kansas-based Home Savings Association (KPERS) lost $65 million after federal regulators seized the thrift when it went bankrupt. Another KPERS investment of $14 million in Tallgrass Technologies Inc. was lost when the investment became worthless. KPERS also invested $7.8 million in Christopher Steel, now an abandoned steel plant.
In another instance, the State of Connecticut Trust Fund paid $25 million for a 47% stake of Colt manufacturing, a locally based company. Just three years later, the pension beneficiaries saw their hopes of any profit dashed. On March 19, 1993, Colt filed for bankruptcy, and the pension beneficiaries will lose almost their entire investment.
The Missouri State Employees' Retirement Fund was forced to invest $5 million in ETI venture capital projects. The program, terminated three years after its inception, realized markedly poor investment returns and resulted in two lawsuits. In Alaska, that state's public employees and teachers retirement system funded $165 million in loans for in-state mortgages. When oil prices fell in 1986, 40% of the loans became delinquent or foreclosed.
Despite these devastating losses suffered by states that have experimented with ETIs, some have continued to dispute whether ETIs lower the return on investment and therefore hurt the future retirement benefits of pension beneficiaries. To answer that question, several economists and researchers have examined ETIs' rate of return with those of more traditional investments. All of these three private studies produced estimates indicating a loss in investment returns attributable to ETIs. A review of their work suggests a range of estimated loss in investment rates of return ranging from 1.18 to 2.40 percentage points.
Even one of Clinton's own economists, Alicia Munnell, did an extensive study of ETIs in 1983 that showed the same results. She concluded that economically targeted investments resulted in a two percent loss on average compared to the normal return. Her conclusion with respect to the effects of ETIs on returns was the following: "In short, pension fund managers failed to exact appropriate returns on very standardized investments, in the presence of obvious benchmarks, once they focused on social considerations." This conclusion follows her own empirical findings demonstrating that ETIs caused pension plans to suffer significantly lower returns, on the order of 190 to 240 basis points, with 200 basis points being a conservative middle-ground.
Other researchers have verified the results of Munnell's study, indicating similar effects of ETIs on investment returns. Olivia Mitchell, one of the premier independent academics who has studied the issue, examined ETIs in detail in a 1994 study. After controlling for differences in size and type of investment, she also concluded ETIs resulted in an average two percentage point loss on returns. The latest studies, conducted by Wayne Marr and John Nofsinger, reviewed three sets of data and found that ETIs reduce returns by 118 to 210 basis points, even after taking into account other factors. The results of these independent studies have consistently shown that ETIs create a two percent lower return.
While these empirical findings on ETIs may not seem too drastic at first, consider the effect of lower rates of return on the huge volume of private pension investments. President Clinton, as governor of Arkansas in the 1980s, enacted a requirement that pension funds direct five to ten percent of total pension assets to ETIs. On the national level, private pensions are currently worth approximately $3.5 trillion. If just 5 percent of the total private pension assets were invested in ETIs, this would amount to $175 billion in 1995.
Using $175 billion as the baseline investment figure, it is possible to quantify the effects of ETIs using the results of the Mitchell, Munnell, and Marr & Nofsinger studies. According to the Employee Benefit Research Institute, the average rate of return on private pension assets from 1990 to 1995 is 12.1 percent per year. If the $175 billion were invested in traditional pension assets that received average returns, the value of these pension assets would be $548 billion in 10 years and $1.72 trillion in 20 years. The same 10 or 20 year returns for ETIs, however, according to the conclusion reached by Alicia Munnell (Clinton's own nominee for his Council of Economic Advisers), would be $458 billion and $1.2 trillion respectively. That means that ETIs would result in a aggregate loss of $90 billion in 10 years and $520 billion in 20 years!
Section 404 of the Employee Retirement Income Security Act (ERISA) is unambiguous: A pension fund manager is required to "discharge his duties with respect to a plan solely in the interest of the participants and beneficiaries and for the exclusive purpose of (I) providing benefits to participants and their beneficiaries; and (ii) defraying reasonable expenses of administering the plan."
Moreover, the requirement that a trustee act solely in the interests of the beneficiaries and exclusively for their benefit derives from the cherished Anglo-American legal principle that a trustee must act with undivided loyalty to the beneficiaries of the trust.
ETIs violate the fiduciary duty of undivided loyalty because ETI investments are made with the intent to benefit non-beneficiaries of the pension trust.
Robert Reich, the Secretary of Labor, attempted to lower the ERISA duty of loyalty by approving ETIs in an official Labor Department Interpretive Bulletin, which defines ETIs as investments "selected for their economic benefits apart from their investment return to the employee benefit plan." (IB 94-1)
In a recent letter to Congressman Jim Saxton, Labor Secretary Robert Reich makes this argument as follows, "We believe that ERISA's fiduciary responsibility provisions are clear." He then acknowledged that, "Fiduciaries of pension plans are obligated under ERISA [Employee Retirement Income Security Act of 1974] to make investment decisions solely in the interest of plan participants and for the exclusive purpose of providing benefits to participants beneficiaries (sic)."
Incredibly, in the very next sentence, the Secretary contradicts himself and in the process totally reinterprets ERISA: "The [Labor] Department has consistently interpreted these provisions as permitting plan fiduciaries to consider the ancillary benefits of an investment. . ." Mr. Reich cannot have it both ways. If ERISA requires fiduciaries to make decisions solely in the interests of and exclusively to provide benefits to participants and beneficiaries -- which it does -- how can it simultaneously permit fiduciaries to consider interests other than those of the participants and beneficiaries or benefits other than those that accrue to participants and beneficiaries? It cannot, even if those other interests and benefits are subordinate to those of the participants and beneficiaries.
ERISA does not say "fiduciaries must make decisions primarily in the interests of and almost entirely to provide benefits to participants and beneficiaries." It says solely and exclusively. Exactly what parts of "solely" and "exclusively" are so hard for the Clinton Administration to understand? This tortured reading of the plain language of ERISA reveals a thinly disguised contempt for congressional intent on the part of the Clinton Administration.
Secretary Reich's own testimony before the Joint Economic Committee on June 22, 1994 provides evidence he has altered the original intent of ERISA. Secretary Reich argued that ETIs must meet two tests: the traditional prudence test in ERISA, and the new Reich test, that "the investment produces collateral benefits to workers and communities." He defends these two tests by arguing that "with [pension asset] holdings so enormous, it's difficult for pension funds to beat the market, because they are the market. The law of supply and demand runs smack into Heisenberg's uncertainty principle: the pension fund community has grown so immense that it cannot make a move without affecting the very market it seeks to outstmart." Secretary Reich talks about two separate tests, but the plain fact is that ERISA does not create two separate tests, but only one: the traditional prudent investor test. By adding such a second test, the finely crafted fiduciary duties under ERISA are undeniably altered.
Furthermore, Secretary Reich also testified that "we will encourage funds to reach for such collateral benefits." Since that time the Labor Department has launched a campaign to encourage ETIs among the pension community, with the Assistant Secretary of the Pension and Welfare Benefits Administration (PWBA) constantly flying around the country to put pressure on pension advisors to start investing in ETIs. Unfortunately, the pension managers who take the Administration's rhetoric seriously and actually invest in ETIs may find themselves being prosecuted by the enforcement division of the very same Labor Department in the not too distant future.
The main purpose of the Pension Protection Act (PPA) is to protect pension beneficiaries from the dangers posed by the risky social investment scheme being promoted by the Clinton Administration. The goal is to restore the undivided duty of loyalty originally written into ERISA that requires pension funds to be invested under the prudence investor standard for the sole purpose of increasing the economic benefit of the pension's participants and beneficiaries. To accomplish this goal, the PPA would nullify Secretary Reich's Interpretive Bulletin which encourages ETIs and would ensure that pension managers do not select investments for the purpose of achieving collateral or external benefits to non-beneficiaries.
The PPA would also abolish the Clearinghouse recently established by Labor Secretary Reich that would have highlighted the list of investments that the Clinton Administration might deem socially beneficial. Lastly, the PPA would force the Labor Department to cease acting as a promoter of ETIs and resume its normal function as the guardian and enforcer of ERISA's fiduciary standards.
Lastly, the PPA would deny funding to any governmental agency that wanted to create a list or database to promote ETIs.
1. Testimony before the Joint Economic Committee, June 22, 1994. This percentage is based on the total pension fund assets of over $4.7 trillion. Public pensions represent roughly $1.2 trillion of that amount, and would not be directly subject to the Clinton Administration's pension plans.
2. Putting People First: A National Economic Strategy, p. 6 (1992).
3. Thomas Donlan, Don't Count on It 108 (1994). See also The Washington Post, Dec. 6,(1992).
4. G. Archibald and J. Seper, The Washington Times, April 10 (1992).
Endnotes:
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