Thursday, December 17, 2009

Canada’s pension “problem” should not be supplanted with “a too big to fail” problem

I have grave concerns about the various solutions that are being touted by political parties and various commercial interests, such as the life insurance companies, to address this country’s pension savings deficit. All of these supposed solutions have problems in terms of creating embedded “too big to fail” risk, via the very nature of what is being proposed, and the notion that bigger is better.

In this context, bigger is not better, by virtue of the fact that bigger also means fewer and fewer means less diversity. To argue otherwise, is to argue that putting all your eggs in one basket is a good thing?

Just as diversity is strength in the natural world, so too is diversity a strength in the capital markets. A far more robust capital market will result in Canada for all participants if we have 1 million players investing $100,000 each on average, than if we have 100 players each investing $1 billion. This is irrefutable. Fewer larger players in the capital markets may give rise to efficiencies of one sort, like administration fees and trading fees, but they also give rise to other larger potential inefficiencies, like institutional biases and institutional mistakes , in whatever form these larger pools of capital take. The examples of this are all around us. Here are just two:

(1) Would the Global Financial Meltdown have treated Canada as well , if we had Caisse de Depot managing $500 billion going into the meltdown, instead of “just” $100 billion?

No, as the Caisse would have become an even larger more problematic “too big to fail” entity than it already was, and would have multiplied the incompetence that we only subsequently learned was rife within that organization.

Instead, Caisse would have required a massive taxpayer bail out, on the basis that it was “too big to fail.”

(2) Would the Global Financial Meltdown have treated Canada as well , if we had Manulife Financial issuing $100 billion of Income Plus variable rate annuity product instead of “just” $10 billion?

No, as Manulife would have been wiped off the face of the earth, as result of its gun slinging practice of not hedging the blind bets embedded into these risks which we only subsequently discovered was going on and which were not being adequately reported on by the company to the marketplace and to policy holders, which is at the heart of a pending multi-million dollar class action lawsuit.

Instaed, Manulife would have required a massive taxpayer bail out, on the basis that it was “too big to fail.”

Hard lessons learned, and near disasters should not be ignored:

So what would it really mean if the solution to the pension deficit problem merely entailed the creation of a few large entities, whose very scale and existence would introduce the risk that their failure might require they be bailed out some day, under the circumstances of being "too big to fail". This would simply become a form of vicious circle with no end, in which taxpayers are bailing out taxpayers. Risks like these can only be spread across large numbers of people (like taxpayers) if the scale of that risk is dramatically less that those who are being asked to bear it. This concept falls apart, once the risk in question becomes too large in scale. This would create the equivalent of chasing one's own tail, or cutting off one's nose to save one's face. It would be an exercise in self-cannibalism. So why create these circumstances of "too big to fail" in the first place, only begging for them to come true?

So rather than ignoring the recent hard lessons of the near disasters all around us from this recent Global Financial meltdown which is the very event that has brought this pension deficit issue to the fore, a better practice would be to heed these hard lessons and near death experiences of Caisse and Manulife and others, and seek solutions that chart a different path than we were previously wrongly headed down.

The public policy response to the looming pension savings “deficit” in this country is not to create a number of super funds, but rather to create new incentives and new vehicles (like income trusts) to allow INDIVIDUALS at large to make individual decisions about the industries and businesses that they wish to invest their savings in. These people should also be free to make their investments by way of vehicles that provide them with the form of return that best suits their investment objectives. Focusing on policies that will better enable large numbers of investors to provide for themselves is to the alternative of focusing on creating monolithic entities to do it for them, is what a deep gene pool in the natural world is to a shallow gene pool. Systems based on greater diversity like deep gene pools, are much better able to sustain the shocks caused by unpredicted adverse events.

So what needs to be done and understood by policy makers to create that more diverse and more shock-tolerant retirement savings solution?

First, it needs to understood that meeting one’s investment objectives is single most important guiding principle of the investment world. Here in Canada it is known as the “Know your client rule”, which is an awkward term used to define this concept. This concept is as simple as identifying what an investor’s risk tolerance is and defining the particular investment goals which he/she is seeking, be it income or capital appreciation. This is where the income trust policy of the Harper government and the inane dogmatic concepts like those espoused by people like John Manley who state that ownership of Canadian businesses by investors should only be allowed to take one form (ie common shares) and not competing forms (i.e. common shares and income trusts) is completely erroneous and misguided, when such is not the case in the US for example. Such a myopic belief that “one size fits all” is harmful to investors, the formation of capital in this country, the vibrancy and robustness of our capital markets and the competitiveness of Canada both in terms of the funding of business but also in terms of providing the means to address Canada’s pension deficit.

Misguided comments such as those of John Manley speak only to the desires of business managers and not to the NEEDS of their owners. DESIRES driven by managers who only seek to maximize their own obscene levels of compensation rather than maximize the value of their businesses for their owners and maximize their competitiveness through a lower cost of capital as the inverse outcome of that.

Ask yourself, if there was to be decision to be made between which is more important, the desires of business managers or the needs of the businesses’ owners, which should prevail? It would only be an anarchist that would side with business managers over the owners. It may not surprise you to know that Stephen Harper’s stated ambition in his year book upon graduating from Richview Collegiate in Toronto was to become an anarchist. He achieved that goal on October 31, 2006, when he destroyed $35 billion of Canadians savings AND destroyed the vastly preferred means by which Canadians had decided they wished to employ to make their investments in the Canadian capital markets. Harper made a completely unilateral and totally biased decision to favour the wishes and whims of corporate managers OVER the NEEDS of the investing public, who are the lifeblood of any capital market, as was described in the Globe and Mail in the piece that appears at the bottom of this page.


The main thought that I want to leave you with is that the solution to Canada’s pensions savings deficit DOES NOT LIE in solutions that would see more money held in fewer hands, but rather solutions that sees the same if not more money held in a greater number of hands and involving a broader array of PUBLIC markets choices. The public markets are what we should be expanding rather than retracting and investment vehicles like income which are better aligned to the investment needs of retirement savings, and which have EVOLVED as a direct consequence o better meeting the needs of the day, should not be taken behind the barn and shot dead, simply because of the false pretenses on which they were condemned to death, such as tax leakage or the fact that they represented a threat to the established (and outdated) order. This is like overturning the very dynamics of evolution itself and favoring the weak over the strong, through artificial and arbitrary means of culling and summary execution

Do people actually think this approach will lead to a better and more vibrant market? To take choice away? To have fewer larger players? To create more too big to fail” lurking disasters like Caisse de Depot and Manulife Financial? If so, then the advocates of such an approach are ignoring the very lessons of the last 12 months and the more universal lesson of life, that diversity is the strength of any large complex system, including the capital markets, in which we should encourage participation by a greater number of Canadians rather than fewer. 20 million Canadian investors are less likely to make monumental systemic mistakes than a few hundred Michael Sabia’s or Jim Leech’s running the pensions on behalf of 20 million Canadians, unless you really think any of these bureaucrats and public servants running these pension funds have any hope in hell of being the next Warren Buffett. Their dreadful performance in attempting to turn BCE into a junk bind basket case would indicate they are not.

These pension fund managers and life insurance CEOs are not the solution to our problem, but more likely they are the source of it. So too, is bending over to the whims and wishes of corporate managers, as occurred here, with great devastation to Canadians seeking solutions to Canada’s pension deficit, on an individual and self reliant basis, rather than through some mega-government means, a solution whose endemic problem in one of solving one problem (pension deficit) by potentially creating a larger one (too big to fail). Better if we create the means for individuals to make their own investment choices and allow individuals to have greater choice about the investment vehicles they wish to support in the market place, like income trusts, rather than adopting tax policies and tax distinctives that are solely designed to kowtow to the self interests of the most rich and powerful in this country.

Why were these “high-profile directors and CEO’s” so paranoid about income trusts and the democratization of Canada’s capital markets that income trusts ushered in? It certainly wasn’t tax leakage, since that is a complete myth of a concept. Was it because they abhor competition and the thought that their abusive means of gross over compensation was at risk? You decide, since nothing else can explain the following act of investor sabotage, and a major contributor to today’s pension deficit issue:

To quote Sandy McIntyre, Chief Investment Officer of Sentry Select Capital. “Income trusts were not the problem, they are the solution”.

Which can only mean that these people and these self interests are the REAL problem:

“High-profile directors and CEOs, meanwhile, had approached Mr. Flaherty personally to express their concerns: Many felt they were being pressed into trusts because of their duty to maximize shareholder value, despite their misgivings about the structure. Paul Desmarais Jr., the well-connected chairman of Power Corp. of Canada, even railed against trusts in a conversation with Prime Minister Stephen Harper during a trip to Mexico.”


Kephalos said...

The Chretien Liberals w/ Martin as the Finance Min did very well putting CPP on a sustainable basis. But there are two problems. The investor's rate of return is too low, and the investor's rate of return is too low (for the employer's share).

CPP only replaces 25% of pre-retirement income and only up to the Canadian wage average (about $42,000/year). To crank 'er to 100% replacement, CPP contributions would need to quad-up. To get a semi-decent pension out of CPP, you'd need to make contribs that are about 40% of the guy's wages.

Still CPP is better than SFA for the 70% of Canadians who do not have defined benefits with iron-clad guaranteed income in their golden daze.

Flaherty really effed 70% of Canadians over so bad it's unbelievable that anyone would want to talk 'pensions' with that deceitful excuse for a politician.

Anonymous said...

The problem with pensions:

The largest problem with pensions is the existence of "defined benefit plans". These plans create a risk that the provider of the pension will not be able to meet the terms of the pensions due to market conditions some time in the distant future. Look to GM to see what a strong negative effect such plans can have on the provider. That private companies are no longer willing to offer these types of plans is entirely reasonable.
Unfortunately, this still leaves 30% of the work force, largely  government employed, with defined benefit plans. This is a significant part of the whole work force and the investment risks these plans create are borne by society as a whole. These plans could attempt to mitigate the risks by investing in only governement bonds. But this presents two immediate problems and one interconnected one.
To start, the returns on government bonds are insufficient to meet the return needs of most pensions plans. Another, more technically correct way of saying this, is that plan contributions by employees and government are and have been too low given the need for risk free investment returns as implied by the term "defined benefit".
The next problem is that there are not enough governement bonds in any case to meet the investment needs of defined benefit plans. There are about $400 Billion ( and increasing) of government bonds outstanding.  The assets of the OTPP, CPP, PSP, OMERS, and  Caisse alone easily exceed this amount. These plans are invested in a diverisified portfolio of assets, not just bonds and so while they can meet their bond needs now, they do so in creating investment risks for the taxpayers that unltimately back these plans.
The final problem is that government bonds that do exist are not backed by income producing assets but by the tax paying ability of Canadians. So once again the burden of offering a risk free return to defined benefit plans falls to tax payers.
Any solution to the pension plan must include the replacement of defined benefit plans by defined contribution plans. In that way, a significantly larger asset base can be invested without creating  investment risk concentrations for plan providers. The investment risk will always be present and cannot be eliminated as no one can say for certainty what a dollar invested in society today will be worth in 40 years. Society has to take that risk, and if all Canadians are to participate in a pension plan, then it is a societal sized investment risk.
Another pillar of the solution must be for the plan assets to be invested in the broadest manner possible. The assets should be invested in a global asset mix so that Canadians benefit from the maximum diversification and are not at risk to their own success or failures. An unintended consequence of investing in a global index is that Canadians will become more sensitised to the success of the world and in doing so will ultimately be morfe open to global progressive economic initiatives.
The final pillar of the pension plan will be to include all willing workers to participate. This raises some technical questions concerning investments amounts and benefit payments, but these are concerns that are well understood by pension plan professionals and so easily dealt with.


Dr Mike said...

I wonder who Jim has included in his Whitehorse group??

Odds are that none of us "little guys" on the street will be there---these are the same Little guys who make up the lion`s share of old guys who will need the pension dollars.

He would be afraid that some of us would bring up income trusts--we might even bring the blacked-out pages--we might even bring the recall letter for those same pages.

Way too much emphasis has been put on those with Company pensions as most of us do not have that luxury.

We have to scratch & claw for every cent--then along comes Flaherty & knee-caps us , killing us financially.

I guess since we won`t be at these meetings , then we probably don`t matter anyway.

Thanks again Jim for nuthin.

Dr Mike

Anonymous said...

They must be meeting in Whitehorse so as to make themselves more accessible to ordinary Canadians.

mathew said...
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