Reflections of a Conservative, Lefty, Right Wing, Do-Nothing, Liberal, Moderate, Tea-Partying Privatizer

Filed Under (Health Care, Retirement Policy, U.S. Fiscal Policy) by Jeffrey Brown on Nov 29, 2010

In American politics, individuals who advocate a move in the direction of more limited government, greater reliance on market force, and who emphasize the role of individual choice are often labeled as conservatives, neo-cons, right-wingers, privatizers, or, in the last election cycle, tea partiers. Those who advocate a greater government role, restrictions on individual choice, and more regulation are labeled as liberals, progressives, left-wingers, and socialists.

Lately, however, I have been thinking about how meaningless some of these phrases can be when describing specific policies reforms relative to the status quo. The reason is that U.S. economic policy as a whole lacks ideological consistency. This reflects, in part, the fact that our existing set of laws and regulations are often creatures of the time period in which they were passed.

As an example, I want to focus on a broad issue on which I have spent much of my professional life as a researcher and policy adviser. Namely, how we as a nation choose to handle risk. In particular, how we allocate risk – and insurance for risks – across the public and private sectors.

If you think about it, the allocation of risk is one of the primary roles of government in the modern era. Indeed, I once heard the U.S. government described as “a very large insurance company with an army.” This is not a bad description. The U.S. government runs the world’s largest life- annuity and disability programs (Social Security), some of the largest health insurance programs (e.g., Medicare, Medicaid, the VA system), a pension default insurance program (the PBGC), a deposit insurance program (the FDIC), an unemployment insurance program, a crop insurance program, a terrorism risk insurance program, and many more.

There is tremendous scope for reasonable and intelligent debate about the appropriate role of government when it comes to intervening in private insurance markets. I do not pretend to have the only “correct” view – how could I, when some of the economists I most respect in this world have come to different conclusions than I have?

But I do believe that I have developed a world-view about what constitutes a sensible and appropriate division of responsibility between the public and private markets that is informed by economic theory, empirical evidence, a dose of experience in how the government operates, and my own ideological predisposition towards individual freedom over government control. The world view that I have developed is one that believes that when it comes to the allocation of risk, we should find the least intrusive role possible for the government that is consistent with providing citizens with adequate opportunities for insuring against risks when doing so enhances societal well-being.

Yes, that is a mouthful. So let me briefly explain. I first note, however, that you need not agree with this world-view to agree with the main point of this blog. But allow me to – very briefly – explain my rationale. Basically, for nearly any economic policy, I go through the following thought process:

1. Can the private market achieve an efficient outcome without government intervention? Here, I define efficiency is the usual economist way of “1st best” outcome that would be generated by Adam Smith’s ideal of a perfectly competitive market without market failures. If the answer is “yes” – as I feel is typically the case with most markets for goods and services, then my belief is that the government should stay out of the way and let markets work their magic.

2. If the answer to question 1 is “no” because of the existence of a market failure (such as adverse selection or moral hazard in insurance markets, the existence of externalities, etc.), then I ask whether the government is capable of over-coming the market failure. Importantly, the answer is often “no.” In many cases, the government faces the same problem as private markets. For example, if there is moral hazard in insurance markets (e.g., if people behave in inefficiently more risky ways when they are insured), then there is very little the government can do about it. The answer is sometimes also “no” because of “government failure,” that is, a political process that leads to even good ideas being poorly implemented due to policy being influenced by special interests or policies being poorly implemented by an inefficient bureaucracy. Whatever the reason, if the answer to this question is “no,” then I will again favor the private market solution, even with its flaws.

3. In the relatively small subset of cases where the private market does not work, where the government has the ability to overcome the market failure, and where the government solution is likely to be designed and implemented in a sensible manner, then I am entirely willing to back such a policy. Even then, however, I will favor the most limited form of government intervention necessary to overcome the market failure. Thus, for example, I have no problem mandating that drivers carry collision insurance because a government mandate can overcome the adverse selection problem that might cripple a purely voluntary market.

Because my approach starts with a belief in the power of free markets and a healthy dose of skepticism about the political process and the skills of bureaucracies, my view is definitely “right-of-center.” But it is clearly not an unabashed “free markets all the time” view because it does recognize a need for limited government intervention in some cases. You may not agree with this view – but it is an ideologically and economically coherent and internally-consistent approach to economic policy.

But now, let us return to the how my views would be labeled by the political process in America today. In practice, application of my world-view to policy means that I often favor having the government encourage insurance through automatic enrollment or even a mandate (in order to overcome adverse selection), but then allowing competitive private market to actually provide the insurance.

But the U.S. is all over the map when it comes to how we treat insurance programs. Consider two dimensions of the problem:
1. Is insurance mandatory or voluntary?
2. Is insurance provided by the government or the private sector?

There are 4 possible combinations of answers, and we have programs in each. Here are a few examples:

Voluntary/Private – dental insurance, 401(k) plans
Voluntary/government – long-term care under the new CLASS Act
Mandatory/private – automobile insurance
Mandatory/government – Social Security, Medicare, PBGC, FDIC

My view is that we ought to have lots of programs in the mandatory/private, when in fact this is one of the least used approaches. What is interesting, however, is how advocating movement towards mandatory/private is viewed relative to the status quo. Over the years I have publicly advocated the use of personal accounts as a supplement or partial replacement for Social Security, and I would be perfectly happy to make them mandatory (or at least the default option). I have also publicly advocated replacing the PBGC with mandatory private pension insurance. I’d also like to see our public sector defined benefit plans reformed so that they have a defined contribution component. In all of these cases, I am advocating a move from mandatory/public to mandatory/private. As a result, I have been labeled a “conservative” or “neocon,” a “right-winger” and a “privatizer.”

In recent years I have also advocated that we consider making annuities the default distribution option from 401(k) plans, and in a blog in October I suggested that we considering mandating that people buy long-term care insurance in order to eliminate dependence on the inefficient Medicaid program. In these cases, where I am trying to move from voluntary/private to mandatory/private, some people labeled me a “lefty” and “liberal.”

Now, let’s take my view about automobile insurance. In essence, I think we have a reasonable approach – namely, that we mandate coverage but allow private insurance providers to provide it. This has not been a major policy issue in recent years. So I can be fairly characterized as having a “do nothing” or “status quo” approach to this policy issue.

At the other extreme, I cannot help but point out that the recent CLASS Act is precisely the opposite of what I would design. It is voluntary, so fails to overcome the main problem in the market but is provided by the government, despite the fact that the private market is fully capable of providing it! Here I just get labeled as a critic.

So, where does this leave me? Am I a right-wing, small government, neo-con intent on privatizing major government programs? Or am I a left-wing advocated who wants to take away individual choice? Or am I a defender of the status quo? Or am I just a critic of government policies?

The answer to all of these questions is “yes.” But this does not mean that I am a flip-flopper or ideologically inconsistent. To the contrary, it means that I am applying an ideologically consistent world-view to a wildly inconsistent set of existing public policies.

At the end of the day, I believe that much of our political rhetoric has become vacuous, school-yard name-calling that does little to illuminate our policy discussions. I find it frustrating – even sad – that we so often mindlessly label and name-call instead of engaging in well-reasoned, analytical discussions of important policy issues.

An Idea for Safeguarding Pensioners and Taxpayers

Filed Under (Retirement Policy) by Jeffrey Brown on Dec 10, 2009

In at least one previous post, as well as in other research papers and articles, I have discussed the enormous problems facing the Pension Benefit Guarantee Corporation (PBGC), the government corporation that insures private defined benefit pension plans.  This week, a very talented MBA student at Illinois – Gagan Bhatia – reminded me of a terrific idea that would go a very long way toward providing plan sponsors with economically appropriate incentives for funding their plans.  Right now, plan sponsors lack appropriate and sufficient incentives to fully fund their plan or to choose a portfolio that immunizes the plan funding from market risk.  Sure, the government imposes funding requirements, but they have proven woefully inadequate.

In fairness, while Gagan Bhatia came up with this idea on his own and independently, it is an idea that has been out there, including in some work by Doug Elliot of the Center on Federal Financial Institutions.  Regardless of who gets credit, I think it is a terrific idea.

In a nutshell, the idea is to increase the seniority of pension claims in the event of a bankruptcy.  When a company files for Chapter 11 bankruptcy, the company’s creditors and claimants fall into different pools as per their priority over the company’s assets. PBGC’s obligations fall into the Unsecured Creditors pool which are paid after the Secured Creditors.   

Under this proposal, the PBGC would be moved up the line and be considered a senior, secured claim.  In essence, it would allow the PBGC to get paid first (or at least earlier than under current law) from any assets that the plan sponsor has remaining.

Why does this help?  Currently, creditors have insufficient incentive to consider the funding status of a firm’s pension plan when the firm is issuing debt.  If creditors knew that the PBGC’s claim on the firm’s assets was senior to that of the creditors, then creditors and potential creditors would become powerful enforcers of economically appropriate funding behavior.  Plan sponsors that failed to adequately fund their pension or plan sponsors who failed to engage in asset-liability matching would be considered – appropriately – to be a higher credit risk.  Thus, the firm would have to pay more to borrow.  Firms that funded their pensions and invested them in a manner that mitigated future funding risk would benefit from lower borrowing rates. 

In essence, this approach would harness market forces to achieve a worthwhile public policy goal.  Along the way, both pensioners and taxpayers would benefit. 

 

 

 

An Expected Surprise: The Doubling of the PBGC’s Deficit

Filed Under (Retirement Policy, U.S. Fiscal Policy) by Jeffrey Brown on Nov 17, 2009

Last Friday, the Pension Benefit Guaranty Corporation (PBGC) announced that its deficit had doubled over the past year.  The PBGC is the government agency that insures defined benefit (DB) pension plans in the U.S.  While this doubling of the deficit was widely reported in the press, the only thing surprising about this announcement was that anyone was surprised by it.

 

Since the PBGC was created through the passage of ERISA in 1974, the basic design of the program has been fundamentally flawed.  As I have discussed in several papers, the PBGC fails to price this insurance properly, fails to provide adequate incentives for funding, and fails to provide adequate information to market participants.  As a result, DB plan sponsors have the incentive – and the legal right – to fund their pensions in a manner that imposes large future obligations on U.S. taxpayers.  (And as for the PBGC experts out there who will quickly point out that the PBGC is not funded by taxpayer dollars, I ask you only one question – given our experience of the past 15 months in which the U.S. government has not only bailed out government sponsored enterprises such as Fannie and Freddie, but also private sector companies such as G.M., do you really think Congress will let millions of pensioners lose their benefits when the PBGC runs out of money?)

 

Given that the program’s finances have been underwater for years, and given that numerous academics, think-tanks, and government policy experts such as the GAO and the CBO have all pointed out that the PBGC is on an unsustainable course, the latest numbers simply confirm what we already intuitively know – the PBGC’s finances are deteriorating rapidly.

 

Here are the facts as of September 30, 2009:

-         The PBGC had only $68.7 billion in assets to cover an estimated $89.8 billion in liabilities.

-         The PBGC “acquired” responsibility for an additional 144 plans during the year.

-         27 large plans – with liabilities of over $1.6 billion are now listed as “probably losses” on the PBGC’s balance sheet

-         The PBGC notes that “potential exposure to future pension losses from financially weak companies” is approximately $168 billion.

 

I do, of course, realize that it is difficult to get people exercised about this issue.  Even $168 billion, let alone $22 billion, no longer seems like a big number coming in a year after trillions have been spent on stimulus plans and TARP-like programs.  Nor does it seem large relative to the tens of trillions in unfunded liabilities facing Social Security or Medicare.  But $168 billion is still real money – even in Washington. 

 

What needs to change?  One useful first step would be to give the PBGC the authority to charge market-based premiums for the insurance it provides.  It is true that this might hasten the decline of DB plans in some sectors.  But I would submit that if making firms pay the true cost of their pensions means that they no longer find it attractive to offer them, then perhaps the efficient outcome is for them to end the plans before they dig the fiscal hole any deeper.

The Case Against Funding Relief for Private Pensions

Filed Under (Retirement Policy, U.S. Fiscal Policy) by Jeffrey Brown on Aug 20, 2009

Given the hundreds of billions of taxpayer dollars that have been handed out to financial services companies, automakers and other companies over the past year, it should not come as a surprise that corporate sponsors of Defined Benefit (DB) pension plans are also coming to Washington looking for a handout.  Admittedly, this issue has not been at the top of the news lately, but given the increasing number of calls I am receiving from policymakers in our nation’s capitol on the issue, it is pretty clear that this issue is on the political horizon.  

 

The basic story goes as follows: Despite the decline of DB pensions in the U.S. over the past several decades, millions of employees are still covered by these plans.  DB pension plans are essentially promises to workers that they will receive a monthly check for life after retirement, and this promise is supposed to be “made good on” even if the firm that sponsors the plan disappears in the interim.  The way Congress decided to ensure this back in 1974 was to require that companies sponsoring DB plans fund them (that is, set aside assets in a trust fund that would be dedicated to paying future benefits), and then provide participants with a government guarantee (through the PBGC) that their benefits will be paid even if the employer goes bankrupt with an underfunded plan.

 

For a variety of reasons that I won’t go into here (I’ll leave that for future posts about pension accounting rules and the flaws of the PBGC – the agency that insures the benefits), most DB plan sponsors invest their pension trusts heavily in stocks.  Thus, when the stock market declined precipitously over the past year, many plans sponsors found themselves facing substantial funding shortfalls. This increases their required contributions at precisely the moment when the economy is sagging.  Earlier this year, Watson Wyatt released a study showing that in 2009, plan sponsors would be required to contribute over $100 billion to their plans, up from just $38 billion in 2008, so the numbers involved are quite large.

 

Thus, the call for “relief.”  Essentially, plan sponsors are asking Congress to allow them to take a pass on meeting their funding obligations (and basically kicking the can down the road to another year).  Doing so, they say, will free up much needed cash to meet other obligations.  The two other uses for the cash most frequently mentioned are to avoid layoffs and to promote investment.  It is therefore argued that funding relief will be an effective economic stimulus.  (Isn’t it interesting how everything looks like a nail when you are holding a hammer?)

 

On the first question, I am unaware of any empirical evidence showing a link between mandatory pension contributions and employment.  On the second point, there is a very nice paper by my friend Josh Rauh (now at Northwestern University) showing that when firms are required to make contributions to their pension funds, they reduce investment (as measured by capital expenditures).

 

Despite these rationale, I remain highly skeptical of the wisdom of funding relief.  My skepticism arises for 4 primary reasons.

 

  1. While I accept the notion that freeing up internal cash may be useful during a period in which external financial markets are frozen, it is not at all clear that funding relief is a useful way to go about it. First, there is no guarantee that Rauh’s results will hold up in a period in which “cash is king.”  Instead, firms may just sit on the cash to provide a safety cushion.  Second, DB plan sponsors strike me as precisely the *wrong* set of firms to target for relief.  Why?  Because they almost surely have lower growth opportunities than other sectors (keep in mind these plans are concentrated in “old economy” firms).  And because these are precisely the firms where assets are most tangible (and thus less susceptible to the information problems that are often used to explain the advantage of internal over external financing).  If we think firms are being prevented from taking on good investments due to problems in the credit market, I’d much rather see us take steps to provide access to credit directly, rather than directing towards an arbitrary subset of firms.
  2. Even if the firms that are granted funding relief use it to increase investment, this will not necessarily increase the aggregate level of investment.  Why?  Because the money used to fund pensions is not thrown in the ocean.  Rather, it is redistributed by financial markets to those projects with the highest present value.  It is quite possible that funding relief will do little more than redirect funds away from the highest value projects in the overall economy and towards the highest value projects within a small subset of firms.  In short, I am not sure there will really be any stimulus to this stimulus.  
  3. This will further increase the risk to taxpayers.  If an underfunded plan sponsor goes bankrupt with an underfunded plan, the benefits are guaranteed by the PBGC.  But guess what?  The PBGC is already underfunded by at least $11 billion (and possibly much higher) and is expected to grow substantially in the coming decade.  At some point, taxpayer money will be needed to fill this gap.
  4. Most importantly, this simply treats the symptom, and not the cause, of the funding problems.  What we really need is a major overhaul of the funding rules – more on this in a future post.