Sunday, August 13, 2017

The Broader Social Consequences of Investment Decisions

In an essay appearing last month in Institutional Investor ("Avenue of Giants,"July 1, 2017), Ashby Monk argued for a broader definition of fiduciary duty. In polling more than 40 large "pensions and sovereigns," Mr. Monk noted that more than half of those surveyed rejected the notion that their decisions would be guided by the consequences for the community they inhabit. The rationale, it appears, is such considerations are quite simply beyond their fiduciary duties.

Mr. Monk went on to note that narrowly defined notions of fiduciary duty, however rational for individual investors or pension managers fosters damaging consequences for the larger investment community. Monks went on to raise a series of questions:

  • Where will the breakout innovations in our industry come from if investors are bound by a prudent-person rule?
  • If some investors hide fees paid to external managers, doesnʻt such secrecy prevent boards from understanding the true cost of producing these returns?
  • If the price of ʻaccessʻ to a given fund is conditioned by outrageous terms or side letters, doesnʻt this further empower private managers to extract higher fees over time? 
Each of these questions illustrated practices by institutional investors posing a larger problem for pension fund managers. A too narrowly defined notion of fiduciary duty overlooks the negative  consequences for not just beneficiaries, but also the larger society. As mentioned in my earlier postings, these are problems requiring, among other remedies, a radical transparency.

Yet even a much greater transparency is not enough to address what is perhaps the most damaging disconnect between a narrowly defined notion of fiduciary duty and the most threatening of consequences in our time. As Monks notes, many institutional investorsʻ strict definition of fiduciary duty discourages them from considering climate change as a legitimate issue.

It is clearly evident that among the pivotal issues confronting all Californians, is the urgent need to more fully comprehend the true costs of a fossil-fueled economy. Whatever the short-term calculus of satisfying a narrowly defined fiduciary duty at CalPERS, perpetuating fossil fuels and associated industries poses an existential threat to the survival of human civilization beyond the 21st century. As Governor Jerry Brown has noted, for those doubting the magnitude of climate threats, one only has to peruse the consensus statements by climate scientists (e.g. IPCC) to understand the especially damaging role of fossil fuels.

For these reasons, it is important for all voters to understand that the election of public-at-large board members of CalPERS in September is not merely a narrow choice regarding some abstract discussions about fiduciary duties and investment returns; elections of all sorts - from city councils to state treasurers to board members for one of the worldʻs largest pension funds will play an increasingly crucial role in making the urgently needed changes for transitioning to a new economy.

I look forward to posting more on this topic in future posts....and thanks for your readership and commentary.

Wednesday, August 9, 2017

Radical Transparency

As noted by Bloomberg News some days ago, "a recent Wall Street Journal editorial, hardly a left-wing Donald Trump critic, called on the president to adopt a new strategy on the Russia probe: "radical transparency." The recommended course of action is perhaps also fitting for the members of the Board of Administration at the California Public Employeesʻ Retirement System (CalPERS).

Among the harshest criticisms leveled at CalPERS is the lack of transparency surrounding varied decisions combined with a steadfast refusal to engage in open discussions regarding its policies. Indeed, another candidate as a board member at CalPERS has detailed sustained efforts by staff and current board members to prevent the necessary deliberations regarding specific policies.

The red-flag rising from such episodes at CalPERS is familiar terrain for anyone who has conducted reviews of state agency practices. In various over-sight investigations/hearings I conducted over my years with Californiaʻs Legislature, similar efforts to prevent more fulsome discussions often signaled practices that directors of agencies wanted to remove from public view. Some observers of CalPERS have referred to such issues as a problem of "CalPERS culture." Framing the issue as one of CalPERSʻ culture, however, is unnecessarily vague in addition to obscuring what needs to be done to turn things around at CalPERS.

Others in Sacramento have analyzed the so-called cultural problem at CalPERS more succinctly: "Look," as stated by one of my experts from the world of finance described the problem to me some years ago, "if you walk into CalPERS and talk to one or another of their financial consultants, you readily comprehend that too many of these folks view their jobs as preparing their vita for the next available position at Carlyle, Goldman, or some other outfit." The CalPERS problem, from this perspective, is not an abstract, fuzzy cultural attribute - it more closely resembles a more traditional problem of agency capture by a private interest. Too many in top management positions perceive their job as meshing their responsibilities with large financial interests, including private equity firms, instead of a career defined by serving the beneficiaries and people of California.

As still other critics have written, CalPERS management has become wedded with a system of rewards promoting risky behaviors when it comes to investments. Paralleling the kind of analysis provided by Michael Lewis (The Big Short), the CalPERS organization shares a potentially dangerous trait marked by many other "masters of the universe" from the world of finance - they have no skin in the game. Losing beneficiariesʻ money is simply an abstract risk having little bearing on various other rewards.

This system of rewards and compensation, revolving doors with clients, and critical reviews of management practices requires a much higher level of scrutiny. And these are only the initial steps necessary to ensure that the primary objectives of serving both beneficiaries and the public is on firm foundation requires a transformation from management practices obscuring decision-making at CalPERS. It is a policy premised on what we might term a "radical transparency."

Friday, August 4, 2017

Public versus Private Comparisons

A few weeks ago, while visiting friends at Californiaʻs capitol, a former colleague mentioned the horrible gap that CalPERS faces with respect to unfunded obligations. If you have followed the discussion of public pension funds over recent years, it is a common basis for beginning discussions about the troubling state of finances facing future generations. Not unlike the discussions surrounding social security, the topic typically moves to a linked discussion: why we must turn to ʻless generousʻ retirement benefits.  The fact that the less generous alternatives (401ks) have their own disastrous performance for a generation of retirees relying on such programs never seems to enter the discussion.

Part and parcel of the agenda for ʻdown-sizingʻ pension obligations is the message that public sector pensions quite simply donʻt measure up to private sector performance. The underlying theme is if CalPERS were run more like those plans managed by private corporations, things would be much better. All of which might sound compelling, unless one happens to have come across recent reports published by that hot-bed of radical financial reporting, Bloomberg News.

S&P 500’s Biggest Pension Plans Face $382 Billion Funding Gap

Brandon Kochkodin and Laurie Meisler provided the following on Bloomberg News: 
"People who rely on their company pension plans to fund their retirement may be in for a shock: Of the 200 biggest defined-benefit plans in the S&P 500 based on assets, 186 aren’t fully funded. Simply put, they don’t have enough money to fund current and future retirees. The situation worsened for more than half of these funds from fiscal 2015 to 2016. A big part of the reason is the poor returns they got from their assets in the superlow interest-rate environment that followed the financial crisis. It’s left a hole of $382 billion for the top 200 plans."
This morning in an updated version of the July article, Bloomberg repeated a similar magnitude of problem facing the retirees for many of the nationʻs largest firms. While many of these same corporations have used revenues to pay dividends to investors, payments to workersʻ pensions are an unmet and growing obligation. As described in Bloomberg: "Companies are eager to get out of the pension business. Most prefer 401(k) plans, where the employee alone bears the risk of falling short at retirement. More are also offloading their pension plans, paying insurance companies to take them on instead."(see "How America Dug a $375 Billion Pension Hole." Bloomberg, August 4, 2017).

The Bloomberg  report does nothing to relieve the deeper inquiry into troubling practices at CalPERS; it does, however, cast doubt on those who would advance the privatization of pensions as some kind of solution.

The record of private sector managed pension funds is not an inspired one for public sector workers. Indeed, the record of corporate managed pension funds underscores the importance of an open and democratic process in the management of pension funds --  a discussion that should be at the center of the upcoming election for Board members at CalPERS.

Thursday, July 20, 2017

Honoring CalPERS

Honoring CalPERS

It is not uncommon for legitimate criticisms of a larger policy or organization to morph into a narrative that unfairly characterizes entire groups of workers. Before launching my summary of various problems at CalPERS, I want to distinguish those occupying the upper reaches of management from the many thousands of other workers employed at the pension fund. Why ?

One of my early lessons in the California Legislature emerged with what for me was a novel political agenda: down-sizing government. While criticisms were readily available to attack the performance of any group of public workers, various partisans were always prepared to use such reviews as the basis for dismantling entire programs, departments, or agencies. Part of what the general public so often missed in the rough and tumble of politics is that those seeking to prove the virtues of running government like a business often engaged covert actions to discredit the work of public agencies. A casualty of these attacks often included not-so-subtle attacks on public workers including their inability to perform their jobs as well as their counter-parts in the private sector.

Arnold Schwarzeneggerʻs original campaign promise for "blowing up the boxes" - ridding the public of the waste and fraud in Sacramento represented a classic example of such baseless attacks on public workers. After months of internal reviews, audits, and task force meetings, many citizens recognized that the actor-governorʻs campaign posture, while perhaps a compelling sound-bite, reflected considerable ignorance regarding the millions of public employees who keep things running across the state.

Teaching our children, maintaining transportation, protecting our environment, and taking care of the elderly represent the daily accomplishments of public workers performing the essential tasks of a modern society. More crucially, public workers perform virtually all of these tasks in accordance to an agenda to enrich the lives of citizens, not to line the pockets of the wealthy. Indeed, it is the conflict between private and public interests that so often represents the heart of so many political battles - a dynamic that certainly appears evident in the conflicts at CalPERS.

At the heart of many critical reviews surrounding CalPERS has been the issue of public participation and inquiry into the management of the pension fund. To many, such arguments sound like a boring transcript containing an abundance of procedural minutia. Yet, beneath the mind-numbing back and forth is a deeper conflict, one involving a tussle between public and private interests. Indeed, it is a classic confrontation where the exclusion of public discussion and transparency reflects the anti-democratic character that so often accompanies private-sector decision-making.

As I explore the criticisms that have been leveled against CalPERS in the coming days, I hope readers will appreciate the important difference that so often exists between the responsibilities and duties of those holding positions of authority versus the much larger group of individuals performing the daily task to ensure for the retirement and well-being for millions of Californians.

Monday, June 26, 2017

Bruce H. Jennings - Your CalPERS Candidate !

Todayʻs post begins a new discussion series focusing on a different topic: the California Public Employee Retirement System. You may already recognize CalPERS as one of the worldʻs largest public pension funds. It is also a place where more than 250 members have nominated me as a candidate to serve on CalPERS Board of Administration - and I owe a considerable debt of gratitude to the hundreds of individuals who have supported me in this endeavor.  During the month of September, the 1.8 million members of CalPERS will cast votes electing two individuals to serve as Member-at-Large to the Board.

One of my objectives as a CalPERS candidate has been inspired by an array of public interest mentors who have guided my work in the Legislature to pursue a common goal: promoting citizensʻ rights to govern the nature and direction of Californiaʻs economy. Promoting citizen participation in managing one of the worldʻs largest economies is also an essential element to address the fossil-fueled crises of our time, a central argument in my book, The War on California. In each of these regards, there is much that needs to change concerning the management of CalPERS.

There are many junctures for Californians to influence the stateʻs economic and political future, including the more than $300 billion dollars managed by CalPERS on behalf of many of Californiaʻs public workers. While up-coming Board election is limited to members of the pension fund, many elected officials figure prominently in the governance of CalPERS (the Governor, Treasurer, Controller and others). While there is much to criticize at CalPERS, there is also a need to recognize the vital importance of public workers and their invaluable contributions over many years.

The politics surrounding CalPERS has been contentious for many years. Starting as a sleepy bureaucracy for receiving and disbursing retirement funds, CalPERS gradually became a more pivotal force with the expanding political might of public employees and their collective financial resources. By the 1960s, CalPERS became a potent tool for influencing corporate boards across the nation and around the world.  CalPERS also became a target for private sector groups eager to exploit economic opportunities for ʻhelpingʻ to manage public employeesʻ portfolios. 

The political role of CalPERS is a topic I will explore in greater depth in the coming weeks along with additional excerpts from my book on related topics. I do not pretend to possess vast knowledge about CalPERS; I am, therefore, especially interested in learning from the readers. Many of us who work politically have often benefited from the collective work of many minds working together, yielding not only important information, but often insights into paths for achieving political change.

As a belated apology, my absence for the past several weeks has been largely unavoidable owing to the launching my book as well as my bid to join the CalPERS Board. Thanks to family, friends and colleagues and the many readers who I hope will join the unfolding discussions.  While my previous writing schedule allowed for postings on Monday, Wednesday, and Friday, the next series will be a bit more episodic.

In addition to reviewing some of the larger controversies enveloping CalPERS, I will also punctuate my postings with observations on the continuing controversies surrounding cap-and-trade.

Thank you in advance for your attention and commentary.

Sunday, April 16, 2017

Establishing Cap-and-Trade: The Climate of Subversion

[Todayʻs post recalls some of the earliest history of AB 32 - The Global Warming Solutions Act - and the conflicts surrounding both its passage as well as its implementation. More than simply a historic footnote, this history would eventually connect to the early policy discussions inside the Trump regime, including Congress, and the direction of ʻcontrolsʻ established on major industrial sources]

On September 27, 2006 Governor Arnold Schwarzenegger signed the California Global Warming Solutions Act into law, to impose a graduated cap on emissions of specific greenhouse gases; and, to allow those facilities responsible for such emissions to utilize market mechanisms to achieve the required reductions. Despite the Legislatureʻs extensive, time-honored tradition of crafting laws where words had specific meanings, the Solutions Act left considerable uncertainty as to the degree to which Californiaʻs climate change policy would be governed by regulatory controls that typically spelled-out who was responsible for reducing toxic emissions, in what amounts, the penalties for failures, and enforcement actions to including citizen ability to file legal actions against corporations… all versus market mechanisms.

At a time when climate scientists increasingly insisted that everyone needed to move decisively to quell the fossil-fueled storms of the 21st century, California was embarking on an uncertain path. Amidst celebrations by the stateʻs actor-governor, Hollywood stars and politicians proclaiming Californiaʻs new law, many public interest advocates wondered how many of the same corporations that had for so long been responsible for the largest market failure in history, were now going to be a part of a market “solution” to global climate change? Community activists in Los Angeles described the recent history of emissions trading as a disaster where public health was sacrificed amidst supposed benefits, far outside their neighborhoods. In places such as Wilmington, California, with its prominent oil refinery, activists wondered about the consequences for their community when Shell began trading emissions credits. In addition to concerns about greenhouse gases, They asked, how could emissions trading curb the use of other pollutants affecting the health of nearby communities?

Assessing the ‘trading’ provision of cap-and-trade in the Solutions Act struck many as theater of the absurd. Regulators, business owners, community activists, environmental lawyers, and private sector financial analysts were openly skeptical about the state’s entry into the world of emissions trading. Even though traditional command-and-control regulatory laws had many flaws, as businesses often complained about regulatory paperwork, many noted that AB 32 now required them to be savvy traders in a new commodity market. 

The relationship between the Solutions Act and other California law was by no means a trivial matter. The Golden State had already enacted a multiplicity of laws and regulations severely restricting the release of toxic chemicals into the air, and a larger array of laws placed California on a path toward eliminating fossil fuels as a source of energy in the 21st century. To all outward appearances the authors of the Solutions Act, breezed through the requisite policy committee. Behind the scenes, however, were serious misgivings about an ill-conceived approach whereby many of the same corporations responsible for emitting hazardous substances into the air should then benefit by credits for reducing emissions elsewhere. Over the previous two decades many activists had played a central role in advancing a series of laws placing California, not simply at the forefront of clean air legislation, but more important, placing significant restrictions on the use of fossil fuels in the state energy supply. Were these hard-earned gains to be undone?

As later reported by an high-ranking administrator in one of Cal EPAʻs agencies, Governor Schwarzeneggerʻs political leanings were clear before AB 32 was even signed into law:

“Governor Schwarzenegger and his staff were intent on delaying substantive work on climate mitigation [in order to protect] California industry - major Republican party donors - from any competitive disadvantage. Schwarzenegger wanted it both ways: to be a climate hero and to avoid alienating the business community. Likewise, the Administration made strenuous efforts to steer the draft legislation away from regulation and toward market trading. That put Schwarzenegger in direct conflict with Democratic leaders who insisted on ʻearly action measuresʻ and who strongly preferred direct emission controls. The latter is precisely why the Air Board was given the lead implementation role: it was world renown for adopting ambitious, technology forcing rules. The Administrationʻs counter proposal for a squishy, non-accountable, multi-agency implementation body was soundly rebuffed. The conflict boiled over once the bill was enacted.”

The early ʻtraitsʻ of Californiaʻs Global Warming Solutions Act would reverberate for years to come.

Wednesday, April 12, 2017

Market Mechanisms for Market Failures: Part I

[In todayʻs posting, we return again to the historic roots of Californiaʻs pollution trading scheme (aka AB 32, the Global Warming Solutions Act) and the many hard-won regulatory laws that preceded it. This history becomes important as a lens for understanding the contemporary politics of fossil-fuel induced crises, including the current push for deregulation by the Trump regime.]

The rising alarm surrounding air pollution during the 1960s lead to the passage of the Clean Air Act in 1970. The essential mechanism of the Act was to establish limits on the release of harmful air pollutants, which principally affected auto manufacturers, refineries, and heavy industries. The regulatory requirements of the Clean Air Act were largely aimed at technological changes, including filters to remove recognized pollutants and meet air quality standards. “By 1991, however, the Environmental Protection Agency had succumbed to the pressure of lobbyists demanding lax enforcement of the Actʻs rules or regulations associated with expensive emissions equipment. EPA targeted Southern California to test a plan that would potentially increase healthy air while reducing emissions by offsetting the cost of pollution controls ….The pilot project, called Regional Clean Air Incentives Market (RECLAIM) established a system for trading ʻpollution creditsʻ among polluters.”

While the authors of AB 32 pointed to an East Coast emissions trading program to limit CO2 emissions (RGGI) as an illustration of how cap-and-trade might operate, RECLAIM was a much closer approximation to the broad contours of the Solution Act. It is likely that the sponsors of AB 32 did not want to point to RECLAIM for one simple reason: it was “widely regarded as a failure due to the issuance of too many emission credits, resulting in weak prices.” Initiated as one of the earliest programs for emissions trading, RECLAIM faced challenges from the start. “Companies had an incentive to achieve escape routes (e.g., variances granted by local air districts) from caps placed on emissions.”

From its inception,  the Los Angeles Incentives Market (RECLAIM) confronted intensive scrutiny from community-based organizations. Communities were already suspect of the basic premise that pollution trading from oil refineries, rail traffic, and other industrial facilities would not impose an even greater threat to their well-being. Various community groups viewed the entire premise of providing regulatory flexibility to the private sector with a blunt skepticism, particularly regarding the benefits of a pollution-trading scheme designed by those working from office towers in New York, Washington, D.C., or San Francisco. The suggestion that they should join with national environmental groups who had designed AB 32 yielded open hostility among a large number of community-based groups in Los Angeles, “This wouldn’t be the first time that they threw us under the bus!”

Another controversy enveloping the proposed trading scheme related to  
what many public health officials referred to as ʻold scienceʻ versus ʻnew science.ʻ Early trading schemes such as RECLAIM emerged during an era when trading was founded on an already dated characterization of ʻpollutantsʻ as chemical hazards posing principally short-term harms. By the beginning of the 21st century, newly emerging scientific findings included a much broader array of harms, reflected in an expanded set of statutory terms (e.g., neurotoxins, microparticulates, endocrine disruption). Because the harms recognized latent effects impacting multiple generations, sometimes at exceedingly small exposures or other times based only the timing of exposures (i.e., first trimester for reproductive effects) legislative discussions moved from how to manage chemical exposures to a more pointed effort simply to eliminate the commercial production or release of substances posing inherent hazards.

Whereas various federal laws were firmly planted in an older model allowing private sector firms to release uncharacterized chemicals into the environment, public health officials and others conversant with these new scientific findings advanced precautionary approaches in law. By the early 2000s precautionary legislation became especially popular in California, with many calling for the rapid phase-out of various products containing bio-accumulative, biologically disruptive, and other such substances (e.g., mercury, lead, PBDEs). The operating premise for a variety of these laws was to prohibit the production, use and sale of substances posing inherent hazards. Lacking this preventative premise, the framing of the Global Warming Solutions Act, therefore, was instantly contentious.

A fundamental question confronting the Legislature turned on how to construct AB 32 within the framework of existing laws, and pointed to very divergent paths. Inside the Legislature, the question pivoted on whether to incrementally manage the release in a calculus of what was most efficient for business. The new research emerging was predicated on the urgency to eliminate these substances posing known and dramatic threats to human life and civilization extending for centuries into the future.

In the years following the enactment of Californiaʻs Global Warming Solutions Act, the question of whether the State should utilize market mechanisms to address a crisis precipitated by what many economists labeled ʻthe greatest market failureʻ would become a pivotal question. In 2017, the question would become dramatically more significant in the context of President Trumpʻs swiftly adopted agenda to dismantle strict regulatory controls, particularly with respect to any restrictions over fossil fuels.

And for readers who are forgiven for not following the minutia of market mechanisms, one additional event in 2017 yielded one more over-looked commentary on the failure of market mechanisms: the decision by the South Coast Air Quality Management Districtʻs Board to terminate the decades-old regional pollution-trading program: RECLAIM. Sparing readers the interesting details, it is enough to note that one of the Board members, the Honorable Sheila Kuehl, noted that Los Angeles was bringing an end to being gamed by fossil fuel interests; LA would revert to the reliable and certain results achieved by strict regulatory controls over emissions by petroleum refineries and other large emission sources.

I promise to provide a less wonky posting next time!