The Detroit bankruptcy is likely to mean a big hit for people’s pensions. Think about that: people have worked all their lives and now you tell them the terms just changed, and at precisely the part of their lives when they will find it hard to replace the lost income.
There are two issues involved in the bankruptcy. One is the outrageous fact that wages and pensions are not treated as secured so they take second place to banks and others whose only skin in the game is money, not the sweat of their brows over lifetimes of work. That’s the legal rule but I’ve never liked it. It creates maximum hardship. Cities and companies go bankrupt for the very reason that they can dishonor their pension obligations. Federal laws require companies to do some things to protect us. But if they don’t do well enough, well, there’s always bankruptcy. That, in my view, is a travesty.
The other problem stems from the types of pension plans involved. As Alan Chartock has commented, pension plans which promise people defined benefits can become very costly to maintain and they become vulnerable. That’s a part of Detroit’s problem.
By contrast, I’m vested in a plan designed for teachers in which my academic employers have promised me only what they would contribute to the plan. That’s called a defined contribution plan. The particular plan, TIAA-CREF, has been quite reliable for more than eight decades. Knowing that, I had a certain sympathy for changing Social Security, EXCEPT that the analogy doesn’t work.
Let me explain. I was lucky. Colleges and universities put me into an excellent plan. If we were all on our own, we’d be vulnerable to every shyster out there.
My wife and I were never financial wizards. We started by investing in a few stocks that quickly became worthless. Even when I started teaching, in my mid-thirties, colleagues at the law school where I first taught, said I should put half of my contributions in TIAA’s equivalent of a bond fund, instead of their stock fund – exactly the wrong strategy for a young family.
My point is that we are highly dependent on the luck of whom we know, trust or get convinced by. We were lucky in spite of those mistakes. The biggest difference is who’s guarding our money. Many of the state pension funds are very well managed and the list of abuses among private brokers, managers and companies is huge.
So, it’s all in the details, or the regulations.
That’s the big advantage of Social Security – the Social Security Administration has no incentive to rip you off. There is a trade-off between security and potential growth, and there is a risk of what the economy and politics may do to benefits. On the other hand, no one is talking about doing anything more than tweaking Social Security, and if we figured the value of our contributions the way private companies do, with interest, it’s a good deal for the government too. But the shift from defined benefits to defined contribution plans, makes clear the critical importance of keeping Social Security as is, to create a relatively secure floor under our old age, regardless of what happens to the portions we invested.
— This commentary was broadcast on WAMC Northeast Report, August 27, 2013.