Why I don't like the idea of defined contribution plans for public employees

The topic du jour in California this spring (or at least one of them) is the proposal by various conservatives to switch California's public employees retirement plan from a defined benefit plan to a defined contribution plan. The differences are really well laid out in this website constructed by the National Conference of State Legislatures, but the difference is essentially this: defined benefit (DB) plans have a formula that defines your benefits based on the amount of time you worked and other factors, defined contribution (DC) plans are based on defined contributions from you and your employer that are invested in a fund that you can personally manage and that will be your own personal pension fund.

The most important distinction for the purposes of California's debate is that when a DB plan's public fund is invested in stocks and bonds that perform poorly the taxpayers foot the bill. However, in a DC plan the government is under no obligation to help out retirees if their portfolio bombs.

The DC plans are understandably being pushed by Howard Jarvis Taxpayers Association and other "starve-the-beast" type groups because DC plans are one more step that we can take away from the new deal and towards an "ownership society" - whatever that means. DC plans will allow retired public employees to manage their own money and, more importantly from the taxpayers' associations' perspective, will ensure that the taxpayers will not feel the burden of making up the difference between the public employees retirement fund and what the state owes its retirees. We're currently having a horrible budget crisis in California. The state is making billions of dollars of payments to retirees every year in replacement of the money lost in the stock market bubble burst. The governor is looking at this as a possible way to provide more long term budget stability.

It smacks of the privatization of Social Security. That's essentially what it is. So all of the arguments that you could make regarding personal retirement accounts would apply very neatly in Californi. And here's what I don't like about the DC plans and the plans to privatize Social Security: they're both financial industry giveaways. There's no way that a public employee is going to be able to manage his or her portfolio in a competent manner - especially not at the end of a long day in the class room or walking the beat. So these future retirees are going to have to hire financial planners that will keep and eye on their portfolios - for a fee. Under the current DB plan, the state retirement fund (CalPERS in this instance) is able to act as their own financial planner because it has an economy of scale. CalPERS is large enough to hire their own, in house financial planners and manage the money of it's present and future retirees.

I believe that the push to move the state towards DC plans is essentially a corporate giveaway to the financial industry. They will earn billions of dollars in the fees they will charge California's retirees to manage their money. I believe that if you did an analysis of all of the states that had switched to some form of DC plans, you would find that the financial lobby had donated heavily in the election just beforehand to the governors and legislators in those states - more heavily than usual.

In addition to the giveaway to the financial services industry, I think there is one other reason that Republicans are pushing the DC plans in California. CalPERS is one of the largest financial endowments in the world. If there is a social cause that is causing world anxiety, Apartheid for instance, then CalPERS can currently use it's financial bulk to influence the politics of another state or a large corporation. Republicans are nervous about giving that much social power to the retirement fund of a heavily Democratic and progressive state. If you think about it, why else would they want to do it here first?They are relatively untested and if there were a problem with them then the only way that we would know is by looking at the last five years in Michigan because that's the only large state that has ever dealt with them (Nebraska had a disastrous experience and have since switched back to the DB plans).

Now, some would say, "but Saku, if CalPERS could manage their own money then the taxpayers wouldn't be paying for their mistakes and this wouldn't be an issue." And I'll tell you why they would be wrong. CalPERS just like most investors, lost a lot of money in the bubble burst. Even the largest, strongest, best performing mutual funds didn't perform that well over the last few years. Everybody lost money. If we smoothed CalPERS financial performance over a few years so that the peaks and troughs were not so high and low then I don't think that we would be having the same problem anymore. I'm not a pension expert so I'll have to do some research on this one.