Wednesday, March 28, 2012

Finance Ministry Warns Local Governments On Pension Fund ...

Anyone remember the 2008 Great Recession? I know I do. One of the warm and fuzzy memories I had was reading about all those pension funds back home in the U.S. that had lost ginormous sums of money betting on mortgage-backed securities. They took a bath on those investments, as did university endowments and a broad swath of financial institutions.

But wait, you say, pension funds are regulated by the state, and their available investment options are proscribed by law. Indeed, and yet there are always two competing interests here. First, as pension funds often represent a major portion of retiree assets, conservatism and stability is usually the watchword. Second, there is the desire to obtain favorable returns on investments. As to the latter, not only does the state have an interest in ensuring that these employees? retirement savings grow as quickly as possible, but in those countries and in those localities where pension funds are in one way or another comingled with other state assets/budgets, then higher returns may also mean a lesser fiscal obligation for the state.

So we usually start off with the safe approach, and then either in periods where interest rates and bond yields are low, or when the financial services industry successfully argues that a relaxation of restricted investments is a good idea, conservatism tends to fly out the window. In the US in the years prior to 2008, investing in mortgage-backed securities was justified not only in terms of greater returns, but also because this paper was AAA rated. We all know how that worked out.

Now put yourself in the place of the Ministry of Finance here, which is hearing arguments from both sides. Here is one opinion from one of my fellow academics at the Central University of Finance and Economics:

Wang Yongjun, head of the Finance Research School at the Central University of Finance and Economics, said allowing local finance departments to invest local pension funds can also diversify investment risks.

Yes, there it is, the old ?diversification of risk? argument, and with China?s rock-bottom interest rates and lack of safe investment choices (in the face of inflation), there is certainly merit to this point of view. Additionally, with an aging population, greater returns are seen as a way to shore up a declining number of individuals paying into the system. On the other hand, the Ministry is well aware of what happened in the US and other countries a few years ago and is being extremely wary of liberalization.

One thing you can say about the government here is that although it is open to reform now and again, it is extremely cautious in doing so. In this case, it?s probably a good thing. Here is what the MOF said in a recent notice:

The finance departments of local governments can?t use the balance of their social security funds for investment, according to China?s Ministry of Finance.

In a notice aimed at strengthening the management of local social security funds, the ministry asked local governments to strictly enforce regulations to maintain the asset value of the pension funds.

I don?t know exactly what brought this on, and why the MOF felt like this was the right time to remind local governments on this issue. However, we do know that the fiscal health of local governments these days is atrocious, considering what?s been going on in the property market and the attempts of the central government to deflate the bubble even if doing so results in a significant loss of revenue at the local level. Perhaps when times are tough, and local governments are feeling the pinch, these big pools of cash might look mighty tempting. But this is merely speculation on my part.

I don?t know about you, but the thought of local government administrators in charge of pension funds during this time of great fiscal difficulty makes me extremely nervous. I hope that the MOF can strike the right balance here between security and adequate returns, but in the short run, I?d err on the side of conservatism.

Source: http://www.chinahearsay.com/finance-ministry-warns-local-governments-on-pension-fund-investment/

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