Bail Ins & Taking Private Wealth
by Daniel R. Amerman, CFA
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The Polish Bail In
The Polish bail in of September 4th, 2013, was quite different from the Cypriot bail in or the new Canadian rules allowing for bail ins. This was not a bail in of a troubled banking system, but rather the entities in trouble were the Polish public retirement system and the Polish government itself.
http://www.reuters.com/article/2013/09/04/poland-pensions-idUSL6N0H02UV20130904
There were in Poland, as a matter of law, two separate retirement systems. One was public, the other was private, and both were mandatory. The public retirement system has had real financial difficulties, while the private system was in much better shape.
The investments within the private pensions were also a matter of law, and about 50% of those private pension funds were invested in bonds, and the other 50% was in equities.
What the Polish government did was to take all of the bonds – which were 50% of the assets of the private pension system in Poland – and bring them into the public retirement system. And because these assets consisted of Polish government bonds, this was treated as a reduction in the amount of debt owed by the Polish government that was equal to 8% of the Polish economy. So it was very significant.
Over the next 10 years, the remaining assets in private pension funds will be drawn out – and the private system will be entirely folded into the public system. This could be viewed as a bail in, in two distinct ways. The first is that Polish workers who had rights to a pension from the more solvent private sector, had their claims wiped out – not due to insolvency or bankruptcy, but rather as a matter of law. It was the wiping out of these claims – via the transfer into the public system – that freed up the assets for the taking by the Polish government.
The second form of bail in is that like many governments around the world, the Polish government was heavily in debt. Through forcing private companies to purchase government bonds as part of mandatory pension programs, and then taking those bonds where they could be netted out since they were now held by the government, it reduced its debt problem – not by raising funds through taxing the general population, nor through insolvency, but instead through reducing claims against the government that had been held by the private sector.
One common point between the Polish and Cypriot bail ins, is that they both took monies from foreign investors on a wholesale basis. In Poland, many of the bonds that were seized were taken from large international corporations with Polish operations and Polish employees, such as ING and Allianz.
So private sector wealth was selectively taken for the "common good", i.e. for the good of the Polish government.
Alternatively, one might say that because these funds were set aside for payment of pensions, and weren't really independent assets of these foreign corporations, that there's a question about whether they were truly expropriated or not.
However, the bottom line is that the people who had as a matter of law thought they had good protection for their retirements in the form of private sector pensions that would support them even if the public retirement system couldn't – had the rug pulled out from underneath them as a whole.
It turned out that for the greater good of the average Polish retiree (and voter), there couldn't be two systems where a private system was prudently funded and a government system was not, but instead there could only be one system where everyone had equal treatment in the name of "fairness".
And that this approach turned out to dramatically slash government debt levels was of course a bonus, as far as the Polish government was concerned.
Poland & The United States
There are some similarities between Poland, with its former public and private retirement funding systems, and the United States with its corresponding dual retirement systems.
Both nations are heavily indebted when we compare national outstanding debt to the size of the economy, with the US government being almost twice as indebted as the Polish government was prior to the bail in. In the United States, the percentage of federal government debt to GDP is very close to 100%, while the corresponding number for Poland was 57%.
In the United States, the duel retirement systems consist of the public system of Social Security and Medicare, and an array of investment-funded pensions and retirement accounts, including traditional corporate pensions, funded state and local government pensions, as well as individual retirement accounts.
One crucial difference between the United States and Poland is that when we look at the US retirement system, including both Social Security and Medicare, it is in far worse shape than Poland. When we look at the numbers calculated by Archer and Cox – the former chairman of the House Ways and Means Committee and the former chairman of the Securities Exchange Commission respectively – the present value shortfall between the assets available in the form of current tax levels and fund balances, versus total federal government claims including Social Security and Medicare, is a staggering $86.8 trillion.
Does it seem reasonable, then, that at some point in the future – if we take these impossible-to-pay debt burdens for the US government in the form of public retirement promises, and we consider the assets available in private pensions and potentially even private retirement accounts – that we could expect a bail in for the good of the public, for the good of the US government, and for the good of the US public retirement system?
Perhaps. The Polish situation would certainly seem to be an indicator that this is a real world possibility at some point when the crisis is far worse than it is right now (at least in the short term). Last week's development in Russia where the government "temporarily" seized $7.6 billion in assets from non-state pension funds for "inspection" is also worth noting. For governments short on cash, fat private pension portfolio balances do seem to be creating a tempting situation for politicians when it comes to rewriting the rules.
However, there is another major difference between the United States and Poland that goes well beyond the far larger amounts at stake in the United States, which is that the seizure of retirement assets held by millions of individual US retirement investors would ignite a political firestorm. There would likely be far greater resistance than there has been in the seizure of retirement accounts from many foreign corporations in Poland.
Implications
We can't yet be certain what the implications are for the spread around the world of this new concept of "bail ins". In looking at Cyprus and Poland, however, it would seem that at the least we should be aware that if we are holding assets in an "offshore haven" , and that nation runs into economic difficulties, that there is a respectable chance that the rules will be rewritten in such a way that the domestic population is financially kept mostly whole, while most of the damage is inflicted on the wealthy foreigners. This is not a mere possibility, but rather it has been happening out there in real time.
Something else to keep in mind, particularly if you are depending on a private pension or private retirement account in the United States or elsewhere, is whether for the "greater public good", there may be a realistic possibility at some point of a merging of private retirement assets in with the severely underfunded public retirement system.
Now this is of course outrageous under the rules as they have been written, and when it comes to the behavior of corporations and individuals investing for decades for their own private retirement.
However, when we look at it from another perspective, if we have entities that are considered too important to let fail – such as the entire banking system, or the entire public retirement system – what bail ins show us is that in the real world, governments are making decisions, as are multi-government organizations – with the EU and International Monetary Fund participating in the Cyprus decision being crucial to remember – where rather than the general public paying for a bail out, instead the more affluent segments of society are targeted to bear the pain for all, in a potentially politically popular manner.
This is the real world, this year.
And this brings to the forefront the central issue that private pensioners and private retirement account investors may be facing over the decades to come, which is when the pressure builds to the point that there is sufficient political reason to do so – we can anticipate that the rules will be changing. And we can already see one clear direction in which they may be changing.
