The American Interest
Analysis by Walter Russell Mead & Staff
The Blue Model Needs Wall Street to Survive

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Many blues style themselves as enemies of Wall Street, defenders of the little guy against voracious or reckless financiers. The branding seems unpersuasive, though, considering that pension fund managers, key stewards of the blue model, keep looking to high-risk, high fee Wall Street for help:

According to a recent report by Cliffwater LLC, an adviser to institutional investors, from 2006 to 2012 state pension funds more than doubled their allocations to alternative investments, which include private equity, real estate, hedge funds and commodities. Totaling almost $600 billion, these nontraditional investments now constitute 24 percent of public pension fund assets. In contrast, the funds dropped their investments in stocks to 49 percent from 61 percent over the six-year period.

There’s a reason for that big move, as explained in a recent International Monetary Fund report. Over the last 10 years, the average U.S. public pension fund earned a return of 6.4 percent a year, very healthy but not enough to meet the 8 percent return guaranteed to government employees. In an effort to take pressure off the state budgets that must cover those deficiencies, the IMF reports that state pension funds have been shifting billions to alternative investments promising higher yields.

The cycle of dependence on Wall Street usually follows a pattern. Public employee union leaders demand generous benefits as the price of their political support; politicians promise things like higher future pay and early retirement. Wary of public backlash, however, these officials don’t advocate cutting services or raising taxes to cover the shiny new pay packages they have established. The discrepancy between benefits promised and funds available becomes unbridgeable. Desperate to keep from falling too far behind, pension funds turn to the risky side of Wall Street, which gets rich off the panic. All too often, the Wall Street solution to blue model imperatives leaves taxpayers and pensioners stranded.

Fingers have been pointed at both sides. A piece in Rolling Stone last month argued that slimy “Gordon Gekko wanna-be[s]” have basically been stealing money in the dead of night from honest, hard-working pensioners. A piece from AEI this week shot back that pension funds are forced to approach Wall Street hat in hand by the self-serving politicians who make unaffordable promises in the first place.

Yes, those responsible for public pensions dug themselves into this hole, but the more interesting story concerns the confluence of interests between blue politicians, union leaders, and Wall Street. It’s unsurprising that few Democrats are willing to acknowledge this; the alliance doesn’t inspire confidence in the blue model’s sustainability or in the political base that supports it.

[Money vortex image courtesy of Shutterstock]

Published on October 25, 2013 5:15 pm
  • Corlyss

    Not to mention Wall Street needs the blue pension funds.
    “Rolling Stone”?
    Really? You’re kidding, right?

    • Bruce

      Actually, Matt Taibbi at Rolling Stone has done exceptional work on the financial crisis, Goldman Sachs, Wall Street’s looting, manipulation of markets etc.
      You could call it hypocrisy to bad mouth Wall Street as blue politicians often do and then turn to them. It’s not pure hypocrisy – it’s politicians and appeal to low information voters. It works, why give it up if you don’t get called on it?

      • section9

        Yeah, Matt’s done great work, but he has this bad habit of excusing Blue politicians and their works from his wrath. In Taibbi’s construct, it’s always the fault of the Street, not the fault of the Blue Model pol who steals from the voters.

      • BigInMemphis

        I agree, but he is hopelessly biased to the point of conflict.

  • Mark Michael

    Then throw in the trial lawyers – the tort bar – and their almost complete alliance with the Democratic Party. They feed on the regulatory state with a plethora of lawsuits, taking advantage of their complexity and near impossibility of not violating some aspect of them. Environmental laws – endangered species, “green” requirements, wetlands covering private property. SEC regulations covering public companies and their stock prices, public information releases. Campaign finance laws, the FEC, and lately, the 501(c)(3) and 501(c)(4) tax-exempt non-profit organizations (NGOs) and the complexity of those regulations. It’s a “target rich” environment for the smart trial lawyer.

    At one time the US had 20 times the number of lawyers as Japan; 8 times when adjusted for population. (Today 310 million vs. 125 million in Japan.) Fortunately, the cost of getting a law degree has gone up so much and we have more lawyers than the market needs, hence, fewer students are choosing the profession. The market is self-correcting to some extent!

    What the GOP and their TEA Party wing should do is stress what decades of D Party governance does to a city like Detroit. What it’s doing to similarly large cities run predominantly by Democrats – or at least the general direction they’re headed unless they do a major course correction. Chicago, Philadelphia, Newark, DC, LA, SF/Oakland/Berkeley Metro area, Baltimore, Cleveland, Pittsburgh come to mind.

  • circleglider

    All of the actuaries and all of the arithmetic in the world won’t prevent corrupt politicians from behaving corruptly.

    Give politicians essentially unlimited and unaccountable control over billions of dollars and expect them to always act “in the public interest?” Why should the private sector be held to a higher standard?

    Maybe this sort of perfection in governance was possible in the ethnically- and culturally-pure participatory citizen democracy that was the idealized New England town square. But it was never intended for nor will it succeed in the diverse and raucous nation that is the United States of America.

    • tomdperk

      In fact, only their improvidence being exposed and them being voted out of office by the public as a consequence will prevent politicians from behaving corruptly and repetitively.

      I think banning incumbency, making back to back terms of public service unconstitutional, will also be of benefit in that regard.

  • lukelea

    There’s no way of getting a higher rate of return on investments without increasing your risks. So what you are really saying is that the pension funds had to start taking bigger chances.

  • teapartydoc

    New look Disqus. Seems to work. Govt websites and govt itself not so much.

  • http://jdwill07.wordpress.com/ JD Will

    Maybe they should have read this:

    http://www.dummies.com/how-to/content/buying-stock-on-margin.html
    That appears to essentially be what these fund managers were doing to bridge the gap. But the unicorn farts came first.

  • HenryC

    Greed on all sides is the problem, asking for more than can be supported, promising more than can be supported, risking what you can’t afford to lose to keep the promise, making good profits off the risk takers win or lose. We have met the enemy and he is us.