HomoEconomus

The Pension Benefit Guaranty Corporation (PBGC) claims that, to avoid a taxpayer bailout, it must shift its asset allocation more heavily toward equities, the Financial Times reported yesterday. The PBGC plans to up its equity allocation from 28% in 2007 to 45% of total assets, and allocate 10% to alternative investments, including hedge funds and real estate. The remainig 45% will be held in diversified fixed-income investments.

As quoted by the FT, Charles Millard, the director of the government-sponsored PBGC, succinctly stated, "The problem is wthat we are underfunded. We are chronically underfunded." Shifting their allocation toward equities "...significantly boosts the likelihood that the PBGC will achieve full funding," according to a PBGC spokesman quoted in the article. The PBGC is running a $14 billion deficit.

Mr. Millard puts odds on the strategy's success, claiming that, "This strategy gives the corporation a 57 per cent likelihood of full funding within 10 years, compared to 19 per cent under the previous policy."

That said, it increases the likelihood of further erosion in funding, particularly if the U.S. economy enters a recession -- just when the PBGC will be needed the most.

Many corporate and public pension funds are chronically underfunded, due in part to their over-reliance on equities over the past decade. The typical U.S. pension plan allocates about 60% of its assets to equities. Even though pension plan liabilities are closely linked to long-term bonds, there are powerful financial incentives for corporations to swing for the fences with equities. Although this strategy looked great during the late 1990s, it had disastrous consequences during the 2001 recession: falling interest rates drove the value of plans' liabilities higher, while the decline in equity prices pushed asset values lower. Many pension plans found themselves in dire straits, which put considerable strain on the PBGC.

As an insurer, the PBGC should be investing anti-cyclically. Generally speaking, the PBGC's services are utilized infrequently in bull markets, since most pension plans are heavily tilted toward equities. However, in a recessionary bear market, the asset-liability mismatch of most pension plans puts them at risk. It is in these markets that the PBGC is called upon most, and that the losses are most severe.

The PBGC's claims of excess returns to equities are also suspect. For example, compare the Vanguard Wellesley Income Fund (VWINX) -- allocated 1/3 to dividend-paying U.S. stocks and 2/3 to high-grade U.S. bonds -- to the Vanguard Balanced Index Fund (VBINX) -- which allocates 60% to U.S. equities and 40% to fixed-income -- and . The former is representative of the PBGC's current allocation, and the latter is representative of the new strategy. The table below summarizes the funds' total returns as reported by Vanguard:

	VWINX	VBINX
1 year	5.61%	6.16%
5 years	7.48%	10.08%
10 years	7.22%	6.41%

Over the past 10 years, the Income Fund outperformed the Balanced Fund by a slight margin, belying the claim that a higher equity allocation offers superior returns. Moreover, during the years 2000-2002, the Income Fund had a total gain of 34%, while the Balanced Fund lost 14%. The relative performance of these two funds during the last recession and bear market suggests that the PBGCs strategy may be ill-timed, and may put the PBGC at great risk to further erosion of its funding.

As if there hasn't been enough news about loose banking controls -- from subprime lending to special investment vehicles to rogue traders -- the New York Times reports that high-ranking employees within Wachovia knew that several telemarketing companies were using accounts at the bank to steal hundreds of millions of dollars from thousands of individuals. Not only was the bank aware of the fraud, but, according to the Times, it continued to solicit the fraudsters' business:

Wachovia continued processing fraudulent transactions for that account and others, partly because the bank charged fraud artists a large fee every time a victim spotted a bogus transaction and demanded their money back. One company alone paid Wachovia about $1.5 million over 11 months, according to investigators.

“We are making a ton of money from them,” wrote Linda Pera, a Wachovia executive, in 2005 about a company that was later accused by federal prosecutors of helping steal up to $142 million.

Can you say, "Due diligence"? Know your customer? Money laundering? Sarbanes-Oxley?

This story demonstrates that there are very good economic reasons why some banks do not institute effective controls. Crime does pay... at least in this case. Controls that reveal profitable fraud can hurt the bottom line. The Sopranos begin to look like a bunch of Girl Scouts.

The scheme reported by the Times was related to unsigned checks for automatic payments. But it's fair to wonder whether similar economics might apply to credit-card fraud?

Take the example of a recent credit-card scam. Although numerous people have reported [see here and here] the bogus charges to their credit-card companies, the scam continues. Is this a case of an unscrupulous merchant paying enough transaction fees to make the banks turn a blind eye? Stay tuned. --GAHjr

In an interview today on ABC's "This Week," Hillary Clinton reiterated that she would garnish the wages of Americans who fail to enroll in her proposed mandatory health-care plan.

There's one problem with Sen. Clinton's policy: you can't garnish what isn't there.

The people whose wages would be garnished would necessarily come from the ranks of the uninsured. According to the U.S. Census Bureau's report on "Income, Poverty, and Health Insurance Coverage in the United States: 2006" (see Table 6, p. 21), of the 47 million uninsured people in the U.S. (16% of the population):

• 22% didn't work at all;
• 30% had annual household income under $25,000;
• 62% earned less than $50,000;
• 80% earned less that $75,000.

These demographic figures help explain why the U.S. poverty rate (12%) is not too far from the rate of uninsured (16%). They also make clear that a policy of garnishing the wages of the uninsured would be a fruitless effort.

Moreover, such a policy could be viewed as unfair and discriminatory:

• Nearly half of the uninsured are black or hispanic;
• 20% are under 18;
• 36% are under 25 years old;
• 22% aren't U.S. citizens.

Finally, the Census Bureau's report gives some indication of what a government mandated health-insurance plan might cost. In 2006, Medicaid covered about 10% of the U.S. population, at a total cost to taxpayers of $300 billion. The demographics of the uninsured lead us to conclude that a government plan to cover that remaining 16% of the population will cost at least this much, if not more.

Much more. The arithmetic puts the figure closer to $450 billion, or $800 per month per uninsured person. That's a lot of non-existent wages to garnish. --GAHjr