Thursday, January 15, 2009

Crisis offers opportunity to fund pensions through SWF

By Michael Metcalfe Published: January 15 2009 02:00 Last updated: January 15 2009 02:00 Amid a financial crisis of historic proportions it may seem odd to focus on a long-term problem. However, extraordinary times offer opportunities to transcend usual narrow interests and create institutions of enduring value. The creation of a US sovereign wealth fund represents such an opportunity. The US should use assets it has already acquired and others it will add in the future, from the troubled asset relief programme as well as other sources. The goal should be to meet the shortfall of pension provision from 2030, when the proportion of retirees will be close to 25 per cent of the population aged 16 and over. One mandate could be to either replace or augment the Social Security Trust Fund and the Federal Old-Age Survivors Insurance Fund, resulting in beneficial outcomes both in the short and long term. Restoring confidence . Collecting assets that represent long-term value to pay the pensions of future generations is better politics and public relations than bailing out individual banks and companies to prevent economic meltdown. As a credible long-term government solution, it would also boost confidence, itself a crucial first step toward recovery. Breaking the liquidation cycle . Redemptions and deleveraging mean that even if asset managers see value in risky assets they are unable to act. In this crisis, only government, acting as a stabilising speculator, can take the necessary long-term perspective. But, if the government ploughed billions of dollars into CDOs, CMBS, mortgage-backed securities, asset-backed commercial paper, preference shares and outright equity, it should make other investors think twice. Repairing the financial system . Until a repository can be found for some distressed assets, the financial system will be reliant on state aid to stay functioning. With dubious assets of uncertain value still on their balance sheets, banks are unable to raise capital in private markets and will not lend to each other. The creation of a sovereign wealth fund to manage these assets would repair the financial system far faster than simply recapitalising dysfunctional institutions. Better than a bad bank . There is no hurry to get government money out. The government's investment is good both for markets and asset values and for the future recipients of the money. The price effect could be boosted by a clear commitment, preferably a legislative imperative, to provide another capital infusion after the first decade of the fund's existence. Governance . The asset pool would be managed by external managers hired by an independent board, which would provide supervision. This would solve the tricky issue of political interference with investment decisions. Giving the assets to professional money managers with a tight mandate and perhaps a performance fee incentive, represents a huge improvement in governance compared with the current situation where the government is buying assets on an ad hoc basis with the justification of the "taxpayers' interest". The Resolution Trust Company experience . In the case of the US thrift industry, about 75 per cent of the residual value of the assets was recovered. Recovery rates may be higher because the SWF could exist in perpetuity and not all its purchased assets are necessarily troubled. Bottom line : In most times and circumstances this proposal is far from modest. It involves the use of government money to buy risky assets, some of which may not get paid back at par. However, this present crisis calls for pragmatism and fresh thinking, not ideology. There is consensus behind fiscal expansion. There is little risk of inflation for several years. The dollar is still the reserve currency of choice and the US Treasury still enjoys the exorbitant privilege of being able to sell an almost infinite number of bonds in its own currency. That may not be the case in 20 years' time. Finally, plenty of undervalued assets are available for longer-term investors to purchase. A US SWF would solve two big issues: injecting capital efficiently into banks and other worthy recipients in the current crisis; and long-term pension funding and the solvency of social security. This environment provides a unique opportunity to create such a fund. The writer is head of global macro strategy, State Street Global Markets

No comments: