Coronavirus Is the Tipping Point That Just Upended Pensions
They bet big, they lost, and if they don’t get bailed out, checks to retirees will start bouncing soon
A pension is designed to be the most boring investment imaginable. Here’s how it’s supposed to work: Every paycheck, some of your money gets automatically invested in a fund. When you retire, you’re entitled to a fixed stream of benefits for the rest of your life. You never see the money that gets invested, and you never wonder about the money that comes back. Simple enough.
Unfortunately — if the coronavirus crisis is any indication — finance is allergic to “boring”: Every dramatic event in the markets starts with a risk that is so close to zero that everyone rounds it down to zero, at which point the risk is a lot bigger because nobody’s hedging.
That’s exactly what’s happening with pensions.
Since the 2008 financial crisis, U.S. pension funds have been making a big, bold gamble: that they can make up the gap between their obligations and their assets by taking bigger, riskier bets. For a while, it looked like this was paying off. Pensions moved more of their money into stocks and juicier asset classes like private equity and venture capital. Those outperformed.
But in the past few weeks, pension funds got squeezed in two directions. Their equity positions went way down, and thanks to the vagaries of long-term interest rates, their obligations went up.
Nobody knows exactly how much pensions owe or exactly what they own, but despite a decade-long bull market, we know they were underwater before the coronavirus crash. The situation is worse now. They bet big, they lost, and if the pensions don’t get bailed out, checks to retirees will start bouncing soon.
However bad you have it, a pension fund manager has it worse, because the real value of their liabilities has soared due to lower rates.
The dangers of duration
To understand just how bad the pension situation is, it’s important to talk about the relationship between bond prices and interest rates…