Pensions and Endowments Will be a Drag on Economic Growth
Posted by Michael A. Kamperman on July 13, 2009
It is not only tight credit markets that will restrict economic growth going forward. One of the bigger drags on the economy will be from the losses absorbed by both pension plans and endowments. In the last few years many chief investment officers have moved their portfolios into economically sensitive investments that have not performed well in the last two years. Many of these investments are illiquid such as direct investments in real estate and timber. What’s worse is many pensions and endowments have invested in private equity deals that require the institutions to cough up more cash as some of these overly leveraged businesses struggle. Pensions and endowments have annual requirements to pay cash out to either the beneficiaries or chosen charities. We have already witnessed the early fallout from these phenomena when Harvard University announced layoffs. Many endowments have payouts tied to formulas that use a fixed percentage of assets based on a 4 year rolling average of the endowments value. The losses in these portfolios will lower the cash they provide to their institutions in the coming years. At least the endowments only have to payout based on the assets that they have.
The more significant drag on the economy will come from underfunded pension plans. Many organizations have made small contributions to their pension plans in the last few years as the growth of plan assets exceeded the cash contributions necessary to keep the plans properly funded. Now, not only will many organization have to begin to make the full contributions calculated by their accountants, they will also have to make catch up payments to cover recent losses. This will create a large and unplanned for payroll expense on large corporations, large charitable organizations, and especially municipal governments including cities and states. A recent study done for some Long Island cities in New York showed that inorder to fund the promised pension payouts to fireman and policeman the cities would need to contribute up to 40% of annual payroll to cover the liability. Needless to say, the only two options short of a rapid rise in asset prices are for these cities to cut jobs or raise taxes. Both will be a drag on economic growth.
The most important question for those like Treasury Secretary Geithner that are predicting a near return to sustainable growth is where will the growth come from? Rising unemployment is killing the consumer. Lower sales revenues are hurting businesses and municipal governments. Going forward, the asset losses experienced by pensions and endowments will affect the real economy. And, the credit markets still remain broken.
