Opening CalPERS to Private Accounts Is a Bad Investment

Should the state manage retirement plans for private-sector employees?

Assemblyman Kevin de Leon (D-Los Angeles) decided that not enough Californians are saving properly for their retirement. To address this concern, he introduced a bill, AB 2940, that would open up the California Public Employees’ Retirement System (CalPERS) to private-sector investors. The idea that more people should invest more for their retirement may be laudable, but the proposal would leave Californians feeling more bearish than bullish.

AB 2940 would allow private-sector workers whose employers do not offer retirement plans such as IRAs or traditional, defined-benefit pension plans to open retirement accounts administered by CalPERS. Contributions could be automatically deducted from workers’ paychecks and sent to the state along with payroll taxes. The account could be taken from job to job, and management fees would be paid by the employee. Gov. Arnold Schwarzenegger has already come out in favor of the bill, but even if it ultimately becomes law, it will still need the approval of the Internal Revenue Service, the U.S. Department of Labor, and perhaps the Securities and Exchange Commission.

Proponents of the measure tout the portability and convenience of the plan, but these features are already found private-sector retirement products. IRAs can simply be rolled over from one employer to another, and contributions can already be automatically deducted from paychecks for employer-sponsored plans (employees without such plans can always set up individual retirement plans through banks, brokerages, and mutual fund companies that will automatically transfer money each month from a checking or savings account to the retirement account).

Some note CalPERS’s low administrative costs as a selling point for the proposal. Its expense ratio of approximately 0.2 percent is excellent, but that is about the same as numerous index mutual funds available from companies like Vanguard and Fidelity, including some that will automatically change their asset allocation to adopt a more conservative investment strategy as one nears retirement.

Others have pointed to CalPERS’s solid investment performance in recent years, but CalPERS’s portfolio may not be right for everyone. People have differing needs, investment goals, and risk tolerances. In addition, investment strategies typically change from more aggressive to more conservative as people get older, the reason being that the risk is worth it when people are younger, since the potential rewards are greater and they have a long time to recoup any dramatic losses, but those about to retire could be seriously hurt by a busted investment. CalPERS’s one-size-fits-all plan doesn’t allow this flexibility and contains too much risk for many, particularly given its investments in risky hedge funds and collateralized debt obligations (CDOs), which are packages of securities backed by mortgages (which may include subprime mortgages), bonds, auto loans, personal credit card debt, and the like.

Even more damning is CalPERS’s penchant for making investment decisions based on political ideology rather than on the financial interests of the workers and retirees on whose behalf it invests its money. Concentrating the power to invest hundreds of billions of dollars in the hands of a small group of politically connected officials necessarily leads to the politicization of investment decisions. This setup allows the pension board to circumvent the democratic process and pursue its political or ideological objectives through the power of the pension purse.

Consider, for example, the “Green Wave” initiative that led CalPERS and CalSTRS (the state teachers’ retirement system) to invest hundreds of millions of dollars in “environmentally responsible” companies and use the pension funds’ financial clout to prod companies to change their environmental policies and “combat global warming.” Then there was the attack on Safeway and an attempt to remove the company’s CEO while it was involved in the grocery strike of 2004. (CalPERS’s president at the time, Sean Harrigan, just happened to also be a senior official with the United Food & Commercial Workers union, which represented grocery workers involved in the strike.) Moreover, CalPERS has a policy to protect state employees’ jobs by refusing to invest in any company that may contract with the state to provide services to taxpayers.

If legislators really want to encourage saving, they should reduce the state’s heavy tax burden and let people keep more of their money to begin with. Then they should take a long look in the mirror. With its $16 billion budget deficit, California has certainly set a poor example of financial responsibility. Rather than trying to compete with the private sector in an industry where there is already robust competition, the state would be better served by getting its own financial house in order.