Goldman Sachs wants your pension


by David Malone

It is time to look ahead.  Not because there isn’t quite enough going wrong right now to occupy us all, but because I am tired of being taken by surprise.  It is time to stop reacting to events and at least try to guess what consequences are going to unfold from what has already happened and what the financial class might be thinking of next.

In the past I have argued that securitization is the Undead Heart (plus part 2, part 3) of the present financial system.  Even if you don’t buy my particular take on securitization there is no doubting its critical importance to modern banking and the broader financial system.  Which does beg the question – what is happening to it now and where is it going?

Securitization, let us remember, is simply taking a flow of future payments from any debt agreement – mortgage, car purchase, corporate bond etc chopping it up into pieces and selling them on.  Instead of having to wait for years to get back the money loaned out, the seller forfeits the stream of future income but gets a cash payment up front and gets rid of the risk of default.  The buyers each get the right to part of the stream of future payments but also accepts the risk that what they paid for might default.

The buyer gets a ‘security’ which gives an income stream and which can be counted as an asset on his books.  The seller gets his cash back so he can make more loans and do it all over again.

Until 2008 the feedstock of securitization was property.  Mortgages provided the flow of debt and cash.  It was a big market and got bigger as the banks expanded who they would lend to from prime to sub-prime mortgages.  What is now clear, however, is that the mortgage market is not recovering as quickly as the banks and financial wizards thought and property is still broadly declining in value in the US in particular.  Securitization needs a new food source.  And it needs to be a big source.  A debt everyone can be persuaded to take on.  Buying a house was a great market, what could be as good?

The short answer is that the big banks are looking greedily at your pension as the way to re-start securitization and save themselves.  I think they are planning to do for your pension what they did for your mortgage.  To move securitization into pensions now would be the perfect outcome for the banks.

Pensions hold oceans of money.  There are company pensions, private pensions held by pension funds and insurance companies and then there is the golden Valhalla of public pensions.  The company pensions are almost universally in trouble.  Almost all company pensions are underfunded – meaning they do not have enough money in them to cover the payments they are contractually liable to pay out.  So they are looking for any suggestion that might save them.

Private pensions in pension company funds are solvent but, like the banks, they would love to offer more pensions and expand their business faster if they could.  But like the banks, only more so, they are required by law to have plenty of assets and income to cover all their promises and payments.  Added to which, because they must invest conservatively, they can only grow so fast.

But imagine if someone came along and bought from the pension companies, the pensions they had agreed and gave them cash in return.  The pension company would suddenly have a pot of cash with which it could offer more pensions.  Which sounds rather attractive.

What would the buyer have?  The buyer, a bank or insurance company, would have a stream of payments (your pension contributions) which is nice, but would also be liable to pay your pension when you retire, for as long as you live.  Which sounds less attractive.  So what’s in it for the banks?

The banks will have paid the pension company what the pension policy was worth to them.  And what it was worth to the pension company was what it could make by investing your contributions over the decades, minus how ever many years of payments you lived long enough to claim.  Being a pension company it would have had to invest conservatively.

The banks will want the pension business because they will figure they can make much more money investing your money than the pension companies ever would.  How?  Banks don’t have to invest as conservatively as pension funds do.  Banks get to take huge risks and yet still be counted as AAA.  Which means the pension companies would transfer your pension to a bank that can take risks the pension company isn’t allowed to take, but still claim your pension is as safe as it ever was, being housed in a AAA rated bank.

The more money the banks make, the better deal they can offer the pension company and the more sparkling the ‘growth’ of the pension pot that the pension company can advertise.  So it’s win, win win.

The key is the banks can do far riskier and potentially lucrative deals that the pension companies are either not allowed to do, would not dare to do because their customers might take fright or do not know how to do.  By selling to the banks all the risks happen behind a curtain.  Behind which the banks can happily make whoopee in the low tax, no tax world of off-shore banking and the regulation free world of the eurobond market.

And that is what I think is likely to happen.  The banks will buy up the risk and income stream of contributions for a pension scheme – sometimes all of it, other times only the risk of having to pay out to those who live too long, and create from the income stream, securities it will either keep or sell on.  Exactly as they did with mortgages.

This will mean the pension company will keep lots of assets still on its books (remember the banks are buying only the income stream not any investment assets the pension scheme had accumulated) but far fewer risks and liabilities.  Having a more attractive balance of fewer risks and more assets will allow the pension funds to recycle their cash faster and offer more pensions to more people and so grow faster.  Just as the banks did with mortgages.  The banks will have more liabilities but a whole new river of income from pension contributions, potentially even larger than mortgages would ever have provided.

If this securitization of pensions matures as it did for mortgages then the banks will retain some of the new pension backed securities as assets and income for themselves, while others they will sell on exactly as they did with mortgages backed securities.  Pension backed securities will be spread into every institution.  The banks will slice and dice them and sell different part of the risk and income to different people.

They will create derivatives which will bet on which pension securities will make money and which won’t.  The securities and the derivatives will be traded on their own markets.  The banks holding the pensions will be attracted to buy and bet on those derivatives themselves, as a way of making more profit.  Trade in such derivatives will bring a volatility to pension backed paper that it has not yet seen.  It will also move much of the pension money off shore and into lower regulatory regimes such as the Eurodollar market.  There will indeed be greater returns, at least in the bubble years, but also far, far less regulation, less transparency and much less prudence, which will kill us all in the bust.

If pension securitization does happen then you and I would not even know our pensions had been securitized and sold on.  Just as we didn’t know it had happened to our mortgages.  Even if we did get to know, the bank would of course be AAA rated.  So the bank would argue, as it did with our mortgages, that our pensions would be safe, because the banks risky deals are balanced by its conservative deals and so in the end your pension would be as safe as … houses?

If I am right then the first moves, which are already underway, will be for the banks to offer to buy company pensions.  Already in 2009 the big British pension company RSA sold part of the income and risk on its pensions to Rothesay Life Insurers.  Rothesay is owned by … Goldman Sachs.  RSA paid Goldman … sorry Rothesay … £1.9 billion.  Rothesay took on the risk that people will live ‘too long’ and Goldman stands behind the deal.

Now, a new report quoted in the FT, from pensions and benefits experts Hymans Robertson predicts,

“that around £20bn of pensions liabilities could be transferred to banks and insurance companies in the next 18 months, taking the total value of this market to £50bn.”

The article quoted James Mullins, head of buy-out solutions at Hymans Robertson saying,

“Banks and insurers continue to offer new flexibility to make risk transfers accessible to all pension schemes … It is crucial that companies and trustees are aware of this flexibility and innovation to ensure that they do not miss excellent opportunities to reduce risk.  In addition, schemes are increasingly keen to manage away as much risk as they can. “

So far, however, we have only looked at company and private pensions held by pension companies.  But the gold Valhalla the banks want to open is public pensions.  Will public pensions ever be given over to the banks and insurers?  If I am even anywhere near the truth, then I think we will see, over the next three years, a huge PR push for privatization of public pensions or parts of them at least.

The argument I think the banks will use it this.  Public pensions are almost universally insolvent in the sense that their liabilities greatly exceed their assets.  The banks will argue that they could invest all that money far more ‘efficiently’ than a mere public service dullard ever could.  Imagine, they’ll say, that you opened those pension pots to us, let us take on much of the risk and the payments in return for the cash flow (maybe you’ll have to sweeten the deal for us by filling up any black holes first and with an up front payment or two) but in so doing we banks would then take off your hands any nasty future liabilities or risk of more black holes appearing.  You would not have to worry any more and not have potential losses looming over your slim budgets and because we, the banks, would make the profits your people couldn’t the pensions would be solvent going forward.  Not only that, they would say, but there is another big plus for you.  That money would re-capitalize the banks that still need to shore up their balance sheets and assure the recovery.  Two of your problems solved with one lot of money.

If I am right, then I would expect to see a growing PR effort in the newspapers saying how unaffordable public pensions are and how much more ‘efficient’ new bank innovations are.  Stories about how this or that company pension has been ‘rescued’ by being transferred to a bank.  And of course the stories will be true.  Those who get in on a Ponzi scheme do make the huge returns.  It is only later, when the scheme becomes saturated and top heavy, that the utter disaster is revealed.

But then think, just for a moment, what would have been achieved for the banks.  What has been the number one justification for knocking down any suggestion that the big banks could be made to accept their losses and not be bailed out?  Hasn’t it been that to let the banks fail would destroy our pensions?

Well, if pensions were now fed into the securitization machine then this link between banks and pensions would become fact.  They would become inseparable in a way they haven’t really been so far.  The banks would have insinuated themselves in to every stage and facet of our lives.  Tied not only to our savings and our houses but to our retirement as well.  No aspect of our lives would be free of them.  They really would be systemically far to big to ever be allowed to fail.  And that is the game now.

For the banks there is no downside.  They would get a vast new market with which to create a new bubble.  And when the bust came, they would simply point out how even more systemically painful it would be to make them suffer losses.  That is what Too Big To Fail is about.  Zero risk no matter what happens.

But for us, in the bust, all the savings and benefits that we were promised would flow from handing them public pensions would be swept away and we would spend even more trillions bailing them out again.  Once the banks are too big to fail they have a forever, ‘get out of debt and jail free’ card.

If we are not careful and do not watch for signs and stand ready to fight against it, this could be what hauls us along to an even greater financial collapse in a few years time.

David Malone is the author of the book Debt Generation. You can read and listen to excerpts from his book here: