OnPoint by Keith Ng

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OnPoint: The Super Fun(d) Shell Game

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  • Matthew Hooton,

    I must be careful not to get obsessed with this issue but I find the stupidity in the arguments to continue with contributions to the Fund while the Crown accounts are so strongly in deficit to be so irritating I'll bash something out ...

    It seems to me that this whole debate is based around the rather banal observation that, most probably, a well-diversified portfolio will, over the long-run, outperform the risk-free rate at which the Crown can access capital.

    (I say "banal observation" because it is something taught in the first lecture of any corporate finance course. I say "most probably" because no one can know the future. It is also relevant to note that only a handful of people have been able to outperform the market average over the long-term time and they are world famous, and it is highly unlikely that our Super Fund will do better than the market average.)

    Given all that, if you make a forecast of what the risk-free rate might be and what the market average might be you get a small margin and you can then "forecast" the difference between them and come up with a number.

    In this case the Treasury has come up with $8 billion, which sounds reasonable but is not a very large amount in the context of the issue - it is less than the negative turnaround in the Crown finances over the last year, and it has to be put into the context of the Fund being worth over $100 billion in nominal terms by the mid-2030s even with an 11 year contribution holiday. Change your assumptions even a tiny amount and the $8 billion can become $16 billion or can disappear altogether.

    The Opposition is quite right to highlight this $8 billion as being what the Treasury forecasts suggest might be "lost" as a result of the decision to have a contribution holiday - and the $8 billion figure is the only relevant one with the wild $31 billion by 2022/23 and $58 billion by 2050 figures completely ignoring that the debt on the other side of the Crown balance sheet would be larger.

    This is the logic that supports the Opposition's slogan that a match has been put to $8 billion. But it is a very fragile number - it can change dramatically one way or the other.

    So, to me, the issue comes down to a very simple question: Is having higher gross debt of some $20 billion by the end of next decade worth seeking this $8 billion at some point beyond that?

    If the answer to that is yes, then it raises the questions:

    1) Why stop at $20 billion to get $8 billion - why not inflate these numbers?
    2) Why wouldnt' we have thought this was a good idea even if there wasn't a Super Fund?
    3) Why don't all Government's use this logic as a substitute for some or all of the taxation they collect?

    That is, those who really believe that the $20 billion for $8 billion is a good idea - either an absolute one-way bet or at least worth taking the risk - need them to give a reason for these particular numbers.

    It is not good enough to say, well because those are the numbers Cullen was intended to put into the Fund if we have remained in surplus.

    Nor is it good enough to say, well that's the amount we need to pay for future Superannuation needs because the Fund was only ever going to meet 11% of the need.

    And how come no other Government in the world is seeing things this way? Why did Gordon Brown raise taxes when he could have said, look, I'm just going to borrow to invest in equities and that will reduce our net debt position in a few years, so you don't need to pay higher taxes now.

    If the borrow-to-save crowd is correct, you would have thought that taxation would never have even developed historically because all government services could be funded through reliance on the banal observation above.

    The other point that needs to be made is that the contribution holiday will not have any material impact on the ability to fund Super payments at current entitlement levels beyond 2030.

    The leaked Treasury paper suggests that the amount the holiday will cost is to reduce prefunding from 11% to 8%. That is, the amount the taxpayer will have to pay for Super will rise from around 89% to 92%.

    That is roungly a 3.37% increase in the amount taxpayers 2030-2050 would have to pay for Super to maintain the 65 year retirement age and the 66% rule. It seems to me it is such a small margin that to launch a globally unprecedented "borrow-to-save" strategy - with the risks it involves - cannot be justified. The results of the investments in shares etc are likely to swing more widely than this 3.37% increase.

    What's more, when people say, well, we either borrow now or borrow later they are not necessarily correct. Our government accounts may be strongly in surplus in 2030. To meet the 3.37% increase, it may be necessary only to reduce the prevailing surplus at that time (or marginally increase the deficit.) Again, this doesn't seem worth the Crown carrying the $20 billion risk over the next decade.

    There seems to be an emotional attachment by some to the Super Fund. But imagine if it did not exist and Bill English had got up in Parliament and said "I have decided to increase borrowing by $20 billion over the next decade to invest in a diversified portfolio of shares and other financial instruments over the next decade, and this is guaranteed to deliver us a one-off profit of $8 billion in the future." I think most people would think that would be barking mad.

    Further imagine he said it today. Imagine if he said that he had been convinced by the arguments and had decided not to borrow $20 billion to get $8 billion but $40 billion to get $16 billion. Would anyone support that?

    The Labour Party's carry on about this whole issue has led the media and others to make a direct and false link between the Fund and future Super entitlements. A debate has begun that says because of this decision the age of eligibility will have to increase. That is false as outlined above but it is gaining currency and may become self-fulfilling. Gareth Morgan and others are making the link. In other words, Labour's antics are making reductions in entitlements post 2030 more likely because a (false) public consensus may build that cuts are now necessary.

    I really struggle to believe that had Cullen and Goff been in Government they would not have taken exactly the same decision Key and English did on this issue. I doubt Cullen will feel he can comment in his new role, because that would be to criticise either his political colleage Goff or his new master English, but it is interesting he had an amusing letter to the editor in today's Dom-Post that did not oppose the Government's decision.

    Auckland • Since Aug 2007 • 195 posts Report

  • Finn Goode,

    I would recommend watching this Yale lecture by the guy running their endowment.

    I see alot of parralels between the Yale story and our own. Over the history of the endowment every stock market crash caused THE FEAR which led to them selling equities buying bonds and missing out on the recovery.

    They shifted to LOTS of risky assets and at the height of the boom the MORONS(read National party) made large claims against the paper value of the portfolio (remember Cullens EVIL surplus). The University spent ALOT more based on the paper value and the govt got angry at Universities for being so damn rich and forced them to spend more on student support.

    Now post crash do you think their endowment is going to repeat the mistakes of the past and shift its portfolio into less risky assets?

    It is obviously too much to ask to expect the government to buy low and sell high but could they at least avoid buying high and selling low?

    i know they wont actually be selling but making smaller contributions to the super fund when assets are cheaper?

    Actually i agree with the hard-left, if we had put that super fund money into education and insulation and health and rehabilitation and....... instead of into financial markets.....

    Its not like we are Norway putting aside all our petro dollars, i reckon we don't owe future people ANYTHING. Just consider how amazing cellphones will be when we start drawing money from the Cullen fund...

    Mt Eden • Since Jun 2007 • 5 posts Report

  • Keith Ng,

    1) The $8 billion is a Treasury projection. The same sort of projection that said we were in surplus a year ago. Projections are risky. Anyone who has been in business will understand the difference between guaranteed return and risk.

    Yeah, so? Do you think that Treasury made its estimate of 8%+ return on the assumption that "Oh, we couldn't *possibly* lose"? These things are all factored in there, so unless you're flat out saying that Treasury is wrong, I don't know what you're trying to say.

    You also overlooked what a credit downgrade will do to the difference between borrowing and saving.

    Problem is, the contribution holiday is just a part of the debt reduction package. The vast majority of it comes out of the reduction in future operating allowance.

    So, let's be wildly generous to your POV: There was a 50% chance of downgrade without the debt reduction package, which would have cost $13b. If you completely discount the NZSF as an asset, then the NZSF holiday is worth, very roughly, 20% of the debt reduction. (If you included the NZSF as an asset in the net debt, as was done previously, then this holiday would actually *add* to net debt).

    Anyway, you're talking about a 20% contribution to avoid a $13b outcome that has 50% chance of eventuating. It's a risk that's worth $1.3b. Not $23.5b.

    Feel free to change the odds, but I don't think you can make a small portion of a $13b risk bigger than $23.5b.

    You are guilty of the same thing as Rob - knee jerk conservatism. If there was no Super Fund today, and Bill English proposed borrowing an additional $2 billion a year, while already borrowing $10 billion a year for the operating deficit, I have no doubt you would condemn it.

    No, I'd look at the rate of return. That's what rational people do.

    2) Treasury does not include tax on the NZSF Fund as a net gain for the economy as if the money was not invested in the fund, it would have been invested in other taxable activities.

    No. It would go to paying off debt. That's *your* point, remember?

    Paying off debt is not a taxable activity.

    3b) You are comparing the cost of borrowing to the economy as a whole, not the Government which is fundamentally dishonest as in 3a) you only look at government debt. So in your nonsense fisking you compare debt to the Govt's debt only (instead of the much much larger NZ debt) but you compare the deficit to NZ GDP instead of Crown Core Income. The $10,000 deficit on $60,000 income example is very close to the Crown account of a $10B deficit on $60b of income.

    3d) Even heard of a threatened credit downgrade?

    Um, so you're defending your analogy, eh? I think I'll just say that households don't operate in the same way as governments, and leave it at that.

    Auckland • Since Nov 2006 • 543 posts Report

  • Gareth Ward,

    Matthew, it isn't about making super special returns, it's about looking at what percentage of GDP we require to pay as super over a 40 year horizon and funding accordingly. It looks solely to smooth the payments to make fiscal control easier.

    Given that, you need to build up a fund of money to pay that smoothing for the first 15 years or so. It's just a reality of smoothing. So given that, it is best to have that money invested somewhere doing something.
    In their own words: "The intention of the Fund is to build up a portfolio of Crown-owned financial assets while the cost of New Zealand Superannuation remains relatively low. These assets will then be progressively drawn on to supplement the Crown's annual budget as its finances adjust to the much higher level of ongoing expense for New Zealand superannuation. In effect, the Fund provides a smoothing mechanism (or 'buffer fund') for what remains, fundamentally, a 'pay-as-you-go' system. In this way the Fund serves its purpose of reducing the tax burden on future taxpayers of the future cost of funding New Zealand superannuation payments."

    Also, there certainly are other Govt agencies that invest their funds for future use - ACC being one that immediately jumps to mind. Govt is, by it's very nature, fiscally conservative though so it is not willing to push the boat out on these.

    Auckland, NZ • Since Mar 2007 • 1727 posts Report

  • Keith Ng,

    Keith: the kicker is the receiving a credit downgrade is not simply $hits and giggles, Treasury estimated that it would add $600 million a year to govt expenditure based on pre 2009 budget debt projections, which ceteris paribus would worth around 13 billion over the time period you are talking of out to 2031.

    Plus, debt costs for the rest of the economy would also rise and that would not have a positive impact on other numbers in budget forecasts

    Yep, absolutely. But it is very important to stress that the majority of the debt reduction comes from the reduction in future allocated operating allowance, not NZSF contribution.

    The Government has managed to smokescreen this very well.

    It's very unlikely that the NZSF contribution was a key consideration for taking us off downgrade-watch.

    Auckland • Since Nov 2006 • 543 posts Report

  • Rich of Observationz,

    other Govt agencies that invest their funds for future use - ACC being one that immediately jumps to mind.

    I've never understood that. I can't see that the future will have an inbalance of accident beneficiaries over contributors, unless life is suddenly going to get more dangerous. Surely the simple fact that ACC averages 4 million small risks means that their income and outgoings are always going to be in step?

    Back in Wellington • Since Nov 2006 • 5550 posts Report

  • Russell Brown,

    Of interest this morning...

    Investment returns boost Crown accounts

    For the 10 months to April 2009, the Super Fund generated $800 million, ACC $500 million and the EQC $200 million.

    The Crown accounts remain in deficit, though investment gains from the New Zealand Super Fund, ACC and the EQC, has put the operating balance $1.1 billion ahead of forecast.

    Auckland • Since Nov 2006 • 22850 posts Report

  • Gareth Ward,

    It's global warming Rich.

    Also, they're moving from a "Govt pays what they need each year" to a more prudent "we're forward covered" position. So the investment arm looks after the amount sitting there for that forward cover.

    Auckland, NZ • Since Mar 2007 • 1727 posts Report

  • Keith Ng,

    The Super fund has the advantage of a long time horizon, which makes poor outcomes unlikely (at least if the experience of the 20th century is any guide to the 21st). But there are still bad scenarios. The next 20 years might see the Chinese economic miracle collapse, or a major war, or the peak-oilers proved right. And there's the problem: those bad scenarios for the Super fund are the very ones where it will be most desperately needed, because they are also bad for the NZ government's fiscal position. That's really what makes the risk intolerable.

    It's pretty hard to avoid the risk of major global events, and if we had to, we wouldn't invest in anything (apart from ammunition and Tamiflu).

    Still, if the NZSF goes belly up, we'll survive. It would have a deep impact on our living standards, but hey, that's what happens when there are major global catastrophes.

    Auckland • Since Nov 2006 • 543 posts Report

  • Gareth Ward,

    Just to make it clear - the Super Fund, ACC Investments etc are NOT playing the investment market to make all this lovely money for the future.

    In the case of Super, Treasury (I presume they look after Super???) have decided it's best to put aside some money now to be prudent given the (pretty solid) forecast ramping up in super demands. The Fund is simply a "well given that we've got that money we should really make it work for us".

    This seems to be a very common misunderstanding as to the point of the investment.

    Auckland, NZ • Since Mar 2007 • 1727 posts Report

  • giovanni tiso,

    Still, if the NZSF goes belly up, we'll survive. It would have a deep impact on our living standards, but hey, that's what happens when there are major global catastrophes.

    Still havent' heard any argumetns as to why what happened in Japan couldn't happen to international stocks.

    Wellington • Since Jun 2007 • 7473 posts Report

  • George Darroch,

    I share Giovanni's concerns.

    WLG • Since Nov 2006 • 2264 posts Report

  • Gareth Ward,

    Well the leading contender for "why couldn't it happen" a few years back when I was up-to-date on Japan was the almost unique industrial/government dominance of their economy. Their economic structure looked nothing like that of Western modern economies.

    Auckland, NZ • Since Mar 2007 • 1727 posts Report

  • Rich of Observationz,

    From the ACC site:

    ...we now collect enough money during each levy year to cover the full lifetime costs of every claim that occurs in that year.

    Some people who are injured need ACC’s help for 30 years or more, so significant reserves must be built up to fund these future costs. This money is invested and earns interest that helps pay the cost of claims.

    This fully funded model is fairer for levy payers. Future generations of levy payers won’t be paying for injuries that happened years before as the cost of those claims will already have been collected.

    So they're actually hedging against a *fall* in the accident rate. I still don't quite see it, because future levy payers are exposed to market risk, as well as to the risk of treatment proving more expensive than forecast.

    A cynic would think it allowed ACC to be neatly packaged for privatisation.

    Back in Wellington • Since Nov 2006 • 5550 posts Report

  • giovanni tiso,

    On the other hand, of course, I'm seeing plenty of arguments that it's exactly what's happening.

    Wellington • Since Jun 2007 • 7473 posts Report

  • Gareth Ward,

    Could you lay these arguments out for me Giovanni? The reasons for Japan's 90's stagflation and how they hold again now in the broader global economy?

    Auckland, NZ • Since Mar 2007 • 1727 posts Report

  • giovanni tiso,

    Could you lay these arguments out for me Giovanni? The reasons for Japan's 90's stagflation and how they hold again now in the broader global economy?

    No, as i'm not an economist. However, Krugman has warned of a Japan-style asset bubble for years (and now he's worried that the counter-measures taken by the Fed and Obama will be just as ineffective as that of the Japanese authorities). Plus when economists talk about "global systemic meltdown" they barely ever not mention Japan, adding for good measure that at least Japan has a ton of our money instead of a debt problem.

    Wellington • Since Jun 2007 • 7473 posts Report

  • giovanni tiso,

    Everybody talks about the lost decade of the nineties and the stagflation. But another ten years later, the Nikkei is worth half as much as at the end of that decade. Which is my way of saying that if you're thinking of investing in Western shares at this point in time, now that our asset bubble is bursting and GM is going bankrupt and our debt is spiralling, you may want to be particularly mindful that past performance is no guarantee of future earnings.

    Wellington • Since Jun 2007 • 7473 posts Report

  • Jeremy Eade,

    Still, if the NZSF goes belly up, we'll survive. It would have a deep impact on our living standards, but hey, that's what happens when there are major global catastrophes.

    Exactly, we are basically putting the superfund into the middle of the world economy. If the world economy stiffs we'll stiff regardless. Why would safe investment be so hard to predict for the next 20 years? The only reason is visibility, accountability and scam. Economies will grow, markets have winners.

    auckland • Since Mar 2008 • 1112 posts Report

  • Gareth Ward,

    Krugman posited a very specific problem for Japan in the 90s though - it was the one time I ever saw him "in the flesh" at a lecture he gave at Auckland uni. They had very poor growth prospects, savings were massively preferred over consumption and it fell into the much feared theoretical liquidity trap, leading to Krugman proposing Government support FOR inflation. There was no underlying asset-bubble cause as I remember.

    That problem is not what the world faces now. The fear around the banks is a case of "Japan didn't react fast enough or correctly to IT'S problem and neither are we". So our Govt reactions are unfortunately the same, but the underlying problems are very different.

    Auckland, NZ • Since Mar 2007 • 1727 posts Report

  • Joshua Arbury,

    It's all about demographics isn't it? At the moment (and for the next decade or two) the baby boomers population bulge will be in the 45-65 age group and therefore in their prime income-earning years. In the future we will have proportionately fewer people in those prime income earning years - so it makes sense to find a way to counter-balance that problem.

    Auckland • Since May 2009 • 237 posts Report

  • Angus Robertson,

    It's very unlikely that the NZSF contribution was a key consideration for taking us off downgrade-watch.

    Do S+P base assessments on short or long term deficits? If short term then the NZSF is the major contributor, if long it is mostly irrelevent.

    Auckland • Since May 2007 • 984 posts Report

  • Gareth Ward,

    Joshua - yes, absolutely. That is the exact reasoning behind smoothing super payments over a 40 year horizon, which leads to a pool of money being built up, which leads to investing that money (Super Fund) rather than having it just "sitting around"

    Auckland, NZ • Since Mar 2007 • 1727 posts Report

  • Geoff Pritchard,

    Matthew's comment is far too long, but dead right. The projections used by Keith and Treasury are just the midpoints of some sprawling probability distributions. But over this kind of time horizon, uncertainty dominates: it's the rest of the distribution that is most of the story.

    The world could indeed catch the Japanese disease, or any of a number of other ailments. Keith seems to want to ignore those possibilities, on the grounds that they aren't in the most likely scenario, and we can't stop them happening anyway. But they matter: NZ will have its best chance of surviving those kinds of external shocks if we haven't put borrowed money into the Super Fund.

    Auckland • Since Jun 2009 • 9 posts Report

  • Gareth Ward,

    But they matter: NZ will have its best chance of surviving those kinds of external shocks if we haven't put borrowed money into the Super Fund.

    No, only under certain assumptions you've made as well. e.g. if those shocks directly affected our revenue base and drove sovereign borrowing rates through the roof, we would be much better having money put aside to help pay super given that we would have real trouble getting our hands on it elsewhere.

    The point is, there are multiple scenarios - but one pretty damn solid one is that the baby boomers are going to retire and the cost of super as a percentage of GDP will be much higher. That's why you smooth it. That's why you put aside a bit of money each year from now on, and that's why you then get a bunch of people to DO something with that money while it's sitting there.

    Auckland, NZ • Since Mar 2007 • 1727 posts Report

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