The long arm of the law
Role of governments and regulations increasingly affects the funds industry
By V G Kulkarni
News item One: The US Tea Party movement wants to privatise social security and scrap President Obama's health care reform. Former Republican speaker Newt Gingrich has said a Republican Congress should "simply not vote the funds" to enable government-run entitlement reforms. The GOP's "Pledge to America" for the mid-term elections, hints at similar forebodings. President Barack Obama and the Democrats are hell bent on fending off the GOP onslaught.
News item Two: The new British government's budget proposals and Prime Minister David Cameron's speech to the Conservative Party conference leave no doubt that "social protection" is up for drastic cuts.
News item Three: The French public is up in arms against the government's proposal to extend retirement age and curtail legally-mandated pensions.
News item Four: Ditto for many a European country even as stringency creeps into Australia and New Zealand.
Flashback to the Reagan-Thatcher era: A bright young British economist told this writer in the mid-1980s, "We don't need the state in the money business; all pensions should be left to be managed by individuals, companies and markets." Now a successful manager at a multinational bank, he is not so sure anymore.
As the items above illustrate clearly, pension funds, asset managers and institutional investors alike cannot but take note of the all too "visible hand" of the state in their business. Most of today's investment professionals have only operated in a market environment of almost free flow of capital and the retreating role of government in business. Most of them would have hardly any experience of the pre-Reagan-Thatcher era of the hold of governments on exchange rates and migration of capital beyond national borders. But the Great Recession of 2008-09 in the wake of the international banking crisis and the resulting legislative measures have shown that the role of the state has not diminished that much.
Historically speaking even the very concept of pension was a creature of governments - be they kingdoms, empires or republics. Some of the early pensions date back to the ancient Roman era. Service for the Caesar at the risk of life or limb was rewarded. While sovereigns would bestow pensions - annuities or land grants - for extreme loyalty or exceptional bravery, the risk of the pensions disappearing with every change of monarch or even dynasty was always there. But all these pensions - from the ancient to the feudal era - were as few as they were arbitrary and there was no sense of certainty or permanency about them.
In the modern era of history, the new awareness that pensions were necessary arose in Europe in the aftermath of the Industrial Revolution. The economies of Europe and later America began expanding at a rapid clip, thanks to the spirit of invention and innovation. It also created a new class of wealthy and powerful industrial barons and merchant princes. Simultaneously, millions of peasants were uprooted from their rural habitats and herded into urban factories and bachelor dormitories; the gap between the rich and the poor widened. The new capitalism's inequality coupled with the economic dislocations caused by periodic booms and busts gave rise to socialistic movements.
Karl Marx published his Communist Manifesto in 1848. Assorted agitated workingmen's groups and their fiery intellectual leaders from Europe came together and held a congress of socialists called the First International in 1865. The Second International was convened in 1889, on the centenary of the French Revolution and that same year the German Reichstag passed the old age pension bill, as a bulwark against insurgent Marxian socialism. Workers, employers and the state shared the costs of the health accident disability insurance as well as the pension.
The moving force behind the German legislation was the "Iron Chancellor" Otto Von Bismarck, who had to badger the conservative legislators and their allies among industrial barons and landed gentry for almost a decade to get his way.
Bismarck's reasoning for social security makes interesting reading even in today's depressed Western world: "The real grievance of the worker is the insecurity of his existence; he is not sure that he will always have work, he is not sure that he will always be healthy, and he foresees that he will one day be old and unfit to work. If he falls into poverty, even if only through a prolonged illness, he is then completely helpless, left to his own devices, and society does not currently recognise any real obligation towards him beyond the usual help for the poor, even if he has been working all the time ever so faithfully and diligently. The usual help for the poor, however, leaves a lot to be desired."
Although Bismarck's law began pensions only at age 65, when the average German longevity was only 45, and only the gritty survivors beyond three scores of years benefited, the concept of state obligation for the social security of the population became established in Europe. Other European states slowly followed suit, but it was not until the early 20th century that its practice was widely adopted - more so after the communist revolution toppled the Russian Czar in 1917. During World War II, the term "Welfare State" was used to contrast Britain against Hitler's Nazi "warfare state."
Unlike the ancient Romans who gave military pensions to veterans of campaigns abroad, Hitler did not outlive the war nor did he promise or propound any ideas on social welfare while in power. Colonised Americans fighting the British promised pensions to veterans as did the federal government later during the late 19th Century Civil War. While some progressive American states took tentative steps in the late 19th Century to aid government employees it was only by 1920 that the federal civil service got a pension scheme. And it took the Great Depression of the 1930s, when unemployment reached 25% and the private enterprise had ground to a halt that President Franklin Roosevelt could enact a comprehensive social security legislation that has since made "Social Security" and "Medicare" household words.
(Personally, President Roosevelt did not need any kind of social security as he was independently wealthy. But his successor Harry Truman was not and there was no pension for US presidents at that time. In January 1953, a retiring Truman even had to buy his own railway ticket back home on a regular train to Missouri from Washington D.C. The Congress had to resort to ad hoc payments to poor Truman until 1958, when a law was passed granting pensions to ex-presidents.)
In the aftermath of World War II, almost all of Europe lay in ruins; only the state could provide essential services and even basic food rations. So the welfare state got another boost. The foundations of most of today's European social security systems - and those of Australia and New Zealand - were laid then. In the succeeding decades, company pensions for workers became common in the growing economies of the industrialised West.
Managing these pension funds itself became a huge enterprise for the new class of asset managers. Abandoning of the market regulations of the Depression era and of the 1950-70s, allowed freer flow of capital and the dominance of the capital markets grew.
But the Great Recession of 2008-09 and dismal fiscal situations of governments have dimmed the prospects of good pensions for the next generation. The runaway markets are being reined in by tighter national and international regulations. Financial lobbies, including those of asset managers and hedge funds have lobbied hard and will continue to fight the creeping regulations. But these will have to be rear-guard battles.
In the broader globalised world, the influence of the emerging market economies is increasing. No longer can G7, a small club of seven industrialised powers, make deals and set the international agenda. The larger G20 is a more likely group to discuss world economic matters and that body has the heavies like China, Russia, India and Brazil and other emerging market nations.
Even in the pension funds sector, a relatively new animal called Sovereign Wealth Funds (SWF) has begun to make its presence felt. Comprising primarily oil exporting countries from the Middle East and cash-rich city states like Singapore, SWFs can only do the bidding of their government masters. Add to this the voices of China and India with their state-controlled pension and insurance outfits. Asset managers will have to give particular consideration to the impact of these governments' interests on their industry.