Government Pension System Needs Reform

When school teachers, police officers and other government employees retire, their pension systems should provide them with the retirement income they were promised. Government pension systems should make conservative, risk-adverse investments, so that an additional burden does not come crashing down on taxpayers.

Unfortunately, some government systems are making risky, speculative investments that put the future of employees and taxpayers at risk. They are investing in initial public offerings (IPOs)--financial instruments that historically have been poor investments. In Michigan, seven government pension funds have lost $10 million investing in Metropolitan Realty Corp., and two Detroit plans lost nearly as much some state, and continued investing in Income Opportunity Realty Trust.

When a loss of this magnitude--nearly $20 million--occurs it is time to reevaluate the existing government pension system. We must not only ask how these catastrophes occurred, but how we can avoid similar tragedies in the future.

Government systems operate like private pension plans in some respects. Money is set aside for employees, and applied toward their retirement. The system's money manager invests in various stocks, bonds, mortgages and other financial instruments. The goal is to earn a rate of return sufficient for the retirement needs of employees.

There is one important difference, however, between government and private plans. In Michigan, disclosure requirements for government plans are virtually non-existent. A school teacher, police officer, or other government employee cannot check the quarterly, or even annual, performance of the system they are enrolled in because the state legislature has never mandated such a requirement. A government plan may be squandering its principal, or it may be charting a prudent financial course. In either case, the public has no way of knowing.

Why would a government pension manager invest in a risky, speculative instrument like an IPO? Dr. Porter Wheeler of the Jefferson Group, an economic research group in Washington, studied the performance of 3,186 IPOs after they were brought to market between 1980 and the decade's end. By the end of 1989, Dr. Wheeler found that only 58 percent of the IPOs were even listed on a public stock exchange. Only one-third had a market price above their initial offering price.

The other 42 percent of IPOs simply disappeared from the market. Among this group, about half went out of business or became too small to be listed on a stock exchange. The other half were merged into other companies.

IPOs definitely fall outside the parameters of what one would call a "blue chip investment." So why did government pension managers invest in Metropolitan Realty Corp. and Income Opportunity Realty Trust? Good questions but there are few real answers. In the case of Metropolitan Realty, the law firm of Thomas Lewand, a powerful figure in Michigan politics, was retained by the New York brokerage firm issuing the stock. Lewand's law firm profited from the issuance of the Metropolitan Realty Corp. IPO, and was later retained by the company as legal counsel.

While this was occurring, the seven government pension plans were losing $10 million. The state Department of Treasury, Detroit, Wayne, and Macomb counties paid $10 per share for the Metropolitan Realty Corp. IPO in 1989. Today, the stock is trading for $5 per share.

The value of Income Opportunity Realty Trust stock has declined even more dramatically. In 1985, two Detroit pension systems--General Retirement and Police and Fire--paid $20 per share for the Income Opportunity Realty Trust IPO--a $15 million investment. In 1989, the two Detroit plans sold when the stock was trading for $7.50. Today, the stock is trading for a mere $1.50.

Perhaps the most ironic aspect of this spectacle is that Detroit's government pension managers were trying to purchase 100 percent of Income Opportunity Realty Trust's stock in 1989 before they liquidated their position. Had they been successful, the system's losses would have been tens of millions of dollars.

Apparently, some government pension managers have forgotten that nobody spends someone else's money as carefully as they spend their own. One way to remedy this problem would be to set investment parameters for managers to follow. For example, municipal insured income funds can only invest in safe tax-free municipal bonds rated AA or higher. Why not set similar investment parameters for government pension plans in Michigan? A good place to start would be to ban them from purchasing IPOs.

Lack of public disclosure allowed the S&L crisis to avalanche into a multi-billion dollar albatross around the necks of taxpayers. We should prevent a similar financial disaster in Michigan by requiring government pension systems to report their holdings and performance on an annual, or even quarterly basis.

Government should be subject to the same disclosure requirements that it imposes on the private sector. School teachers, police officers and every other government employee have a right to know how their pension system is performing.

Finally, why not take public disclosure one step further and require government pension managers and their financial associates to place their personal investment holdings in blind trust? Government power requires checks and balances or it will lead to private abuse. By not requiring managers to place their holdings in blind trust, the government is leaving the door open to potential abuse.

The stakes are high--the retirement income of tens of thousand of public employees, and the financial well-being of taxpayers--for these reforms to be overlooked. Continuing down the current path of lax regulation of government pension systems in Michigan invites another disaster.