Dire need of modern framework for management of public pension funds
The purchases of overpriced Greek government bonds by state pension funds and the alleged cases of corruption involved would not have taken place if the country had a modern institutional framework for managing the pension funds’ money. The responsibility for lacking such a framework rests squarely with all the political parties which have governed the country in the last few decades. However, a modern framework should be put in place as soon as possible. As cases of more state pension funds which had bought government bonds at extraordinary high prices in the last few years come to the fore, many politicians think the best way to deal with the situation is by starting the familiar game of pointing the finger at each other. Meanwhile, the local press is busy looking into new cases of alleged corruption involving bonds and pension funds. Political ramifications Although everyone understands the political ramifications and how important it is to deal with the political fallout of what seems to be a scandal of unknown proportions, it is even more imperative for the country to move forward. In some ways, what is happening is healthy for two reasons. First, it will hopefully put an end to dubious money management practices sanctioned by the boards of some pension funds and probably send some of them and the middlemen packing. Second, it makes everybody understand the importance of speeding up the process for choosing and legislating a modern framework. This may sound strange to everyone who is familiar with Greece’s aging population and acute social security problem – described by some analysts as the worst among eurozone countries. This is more so given the fact that the ruling conservative New Democracy party and the socialist PASOK party treat social security reform as a hot potato while leftist political parties think of it as a sacred cow requiring no major overhaul but money from the budget to finance the ever-growing deficits without worrying about the negative effects on economic growth. The European Commission projects Greece’s public debt will rise to 255.5 percent of GDP on higher pension and health-related spending if the main parameters of the social security system, such as contributions and retirement age, remain unchanged. Faced with this situation, Greece has done little more than establish three committees so far in the last three years to propose measures to modernize the existing antiquated framework for managing the property of social security funds. The decision to basically scrap the proposals of the second committee – headed by the deputy governor of the central bank, which submitted its proposals to the labor minister a few weeks ago – and establish a new committee to undertake the project was made a couple of weeks ago. At the same time, the same ministerial committee decided to prohibit pension funds from investing in structured bonds, even if they had been issued by the Greek state, in a move which aimed more at controlling political damage than helping some of the pension funds – which had bought some of the bonds at high prices – to recuperate their losses. Structured bonds Surprisingly, from an investment point of view, the best thing for these pension funds would have been to buy more of these structured bonds in the secondary market to lower their acquisition cost in their books and take advantage of the steep drop in their prices due to the flat euro yield curve. The 12-year structured bond which had been issued by the Greek state and purchased by four state pension funds from a local brokerage firm at inflated prices reportedly features a coupon of 6.25 interest for the first two years and pays five times the difference between the 10 and the two-year euro swap rate. The fact that the difference between the 10- and the two-year bond is close to nil nowadays explains the steep drop in their price. However, even more important is Greece’s inability to come up with a modern framework for managing the social security system’s money and do away with the current one, which is too restrictive. Under the current framework, social security funds can invest up to 23 percent of their assets in securities and real estate. Out of this 23 percent, up to 60 percent can be invested in stocks and the remaining 40 percent in real estate property. Moreover, they can invest only in Greek stocks and bonds listed on the Athens Stock Exchange, especially those stocks making up the blue chip FTSE 20 index and the mid-cap FTSE 40. They can also invest in derivatives but only to hedge the stock portfolio risk. Also, the Labor Ministry and the Bank of Greece will have to agree before social security funds proceed with the sale of bank shares. This means Greek pension funds cannot hope to attain the same risk-adjusted returns as their counterparts in the eurozone, which are allowed to invest in securities of companies and governments of other countries other than their own. It is no coincidence that EDEKT-OTE – the management company which was established by the state, OTE, OTE’s pension fund and others to manage about -528 million in 2002 – has produced superior results to other state pension funds since its inception. Social security funds put a good chunk of their reserves with the central bank. EDEKT-OTE has mandated international investment banks and specialized houses to invest part of the money in eurozone equities, including Greek ones, and part in eurozone government bonds. Another example is the Mutual Fund Management Company set up by IKA, Greece’s largest pension fund. So, there are successful examples of professional management of pension funds’ money in Greece which can be duplicated. Of course, the problem is not setting up such companies to manage money. Even more important and difficult is to put in place a strong corporate governance system for such companies to discourage any attempt at wrongdoing by board members and others. It will be great if politicians start thinking about these issues and stop bickering about the past.
