The case against pension-financed infrastructure
By Edward Zelinsky
Media reports have indicated that New York Governor Andrew Cuomo has been considering the use of public pension funds to finance the replacement of the Tappan Zee Bridge and to underwrite other infrastructure investments in the Empire State. This is a bad idea, harmful both to the governmental employees of the Empire State and to New York’s taxpayers. Using public pension monies in this fashion trades the immediate benefits of public construction for the long-term cost of underfunded public retirement plans.
If investment in the new Tappan Zee Bridge yields risk-adjusted, market rate returns, then private investors will step up to the plate and invest. Resorting to special financing arrangements with public pensions signals that a proposed investment does not pass the test of the marketplace. Market rate returns attract private capital. Such investments need not be subsidized with public pension monies.
There are projects which yield social benefits beyond their financial returns to investors. In a democracy, voters (or their elected representatives) can and should be persuaded in open deliberations to finance such projects with their tax dollars.
When governmental officials (however well-intended they may be) resort to special funding arrangements with public pension plans, it indicates that the investment in question flunks both the discipline of the market and the legitimacy of voter approval.
Such projects flout the venerable fiduciary standards for pension investments, namely, prudence and diversification.
An investment shunned by private investors is imprudent. When made by a state pension plan, such a below-market investment impairs the long-term interests of both the employees who depend on the plan for their retirement incomes and of the taxpayers who ultimately finance the plan. A prudent pension investment must, at a minimum, yield a risk-adjusted, market rate return. If pensions make investments rejected by private investors, such below-market investments are imprudent.
Moreover, an investment by New York pensions in New York infrastructure fails the test of diversification. In the private sector, it flouts the rule of diversification for a private retirement plan to invest its resources in the stock of the employer sponsoring the plan. The plan is already dependent upon the economic well-being of the sponsoring employer since the employer funds the plan. Placing the plan’s resources in the employer’s stock doubles the pension’s bet on the employer and its economic condition.
Similarly, if New York’s public pensions invest in New York projects, the pensions are doubling their bets on New York’s economy. These plans already count on New York’s economy for the tax revenues funding such plans. Concentrating New York pension investments in the Empire State is the opposite of diversification; the financial fate of these plans is already tied to New York’s ability to fund them.
The budgetary pressures on Governor Cuomo and other states’ chief executives today are severe. Those pressures make it tempting to turn to public pension funds to finance infrastructure when private investment can’t be obtained and voters cannot be convinced to pay taxes for such infrastructure.
It is precisely at such moments that the sage tests of prudence and diversification play their most important role – protecting the long-term interests of retirees and taxpayers by precluding pension trustees from making investments which flunk the criteria for sound fiduciary decisionmaking.
The most recent reports indicate that Governor Cuomo may be reassessing the desirability of using public pensions to finance in-state infrastructure investments. Let us hope so. A new Tappan Zee bridge is a great idea. It should be pursued the right way, by formulating the bridge’s financing so as to attract private capital, voter approval or both. Special below-market deals for public pension plans are the wrong way to fund public infrastructure.
Edward A. Zelinsky is the Morris and Annie Trachman Professor of Law at the Benjamin N. Cardozo School of Law of Yeshiva University. He is the author of The Origins of the Ownership Society: How The Defined Contribution Paradigm Changed America. His monthly column appears here.