The Great Recession undermined the structural foundations of Western pension systems for two reasons: First, because it slowed growth, lowered revenue, and increased fiscal strains across the board, and second, because it forced central banks to dramatically cut interest rates, sharply reducing the bond yields that make up a substantial portion of pension portfolios. The Wall Street Journal reports:
Central bankers lowered interest rates to near zero or below to try to revive their gasping economies. In the process, though, they have put in jeopardy the pensions of more than 100 million government workers and retirees around the globe. […]Managers handling trillions of dollars in government-run pension funds never expected rates to stay this low for so long. Now, the world is starved for the safe, profitable bonds that pension funds have long needed to survive. That has pulled down investment returns and made it difficult for funds to meet mounting obligations to workers and retirees who are drawing government pensions.
Because they have a low tolerance for risk, pension funds “have roughly 30 percent of their money in bonds,” according to the WSJ. When bonds paid 10 or 5 or even 3 percent annual returns, this was perfectly sustainable. But now U.S. Treasuries yield close to nothing when adjusted for inflation, putting more pressure on pension managers to engage in risky investments in order to reach the returns they need. This has hit Democratic-leaning state and local governments in the United States particularly hard:
Weaker cities across California could face bankruptcy without help, said former San Jose Mayor Chuck Reed, who oversaw a pension overhaul there in 2012 and is backing the 2018 initiative that would shift onto workers any extra cost above the capped levels. “Something is broken,” he said. “The plans are all based on assumptions that have been overly optimistic.”
Central bankers had little choice but to depress interest rates to help growth recover in the wake of the financial crisis. But this era of zeroed-out rates will nonetheless be remembered as a great tradeoff, keeping the economy afloat in exchange for the accelerated dismantling of the blue model pension and social insurance systems that we have taken for granted for decades.This story highlights a broader point: Many of the fiscal and monetary assumptions that the West has relied on since World War II are being called into question by globalization, technology, and demographic change. The managerial class needs to think outside the box to address this challenge, rather than doubling down on creaking institutions whose time has passed.