Case studies of putting public funds in stocks

For all the controversy surrounding President Clinton's plan to invest Social Security money in the stock market, you'd think the notion was radically new and dangerous to the republic.

New it isn't. States have been investing public pension and school funds in the equity and bond markets for years. As for dangerous, that seems to be a matter of opinion.

Some economists - including Federal Reserve Board Chairman Alan Greenspan - are wary of such programs. They say politics would inevitably creep into the decisions of government-run stock funds, bringing a heavy-handed influence to Wall Street and often poorer results for pensioners. Yet several states have continued to operate such programs - often with good results.

State officials acknowledge that politics can enter into the decisionmaking - for example, controversy erupted over Texas' investment in Disney stock. But, for the most part, they maintain that stock-market programs consistently yield more than those that stick to traditional bonds.

With Mr. Clinton staking a significant part of his legacy on his attempt to save Social Security, the issue of putting public money in the stock market has received unprecedented scrutiny. And with hundreds of billions of federal dollars at stake, comparisons with smaller state funds aren't perfect. Still, many experts are looking to the states to see what lessons can be learned.

So far, the results have been somewhat mixed. Generally, states are getting a good return on investment, but experts say they could be doing better. One key reason, they say, is that most states maintain some control over the investing, and this can lead to decisions that are made for social or political reasons.

"Anytime you get a big chunk of money in front of politicians, you run the risk of investments made not in the best interests of the beneficiaries," says Rick Dahl, chief investment officer for the Missouri's State Employee Retirement System. And political or social decisions can affect how a pension plan will perform, often in negative ways. Examples are numerous:

*In 1990, the State of Connecticut Trust Fund for pensioners lost $25 million investing in a Colt firearms factory in a losing bid to save local jobs. Three years later, Colt filed for bankruptcy.

*In 1991, the Kansas Public Employees Retirement System (KaPERS) was accused of conflict of interest when it invested $65 million in a failing local savings and loan. The head of KaPERS had once been director of the thrift, which eventually failed, leaving KaPERS with a complete loss on its investment.

*In 1987, a new state law required Missouri's State Employee Retirement System to invest up to 5 percent of its fund in local start-up companies. After three years and a $5 million loss, the law was rescinded.

The list goes on. But experts in the pension industry also say that every investment house - public or private - has its own horror stories. And besides, not all political decisions turn out badly.

"Some of them [investments] have turned out well, some of them have not," says Olivia Mitchell, a professor at the University of Pennsylvania's Wharton School of Business in Philadelphia.

In many ways, Texas makes an interesting case study for how politics can affect a public fund's earnings. Last year, members of the conservative-leaning state Board of Education divested the state's Permanent School Fund of its Disney stock. At the time, religious conservatives were boycotting Disney for adult movies such as "Pulp Fiction," which were distributed under a subsidiary label, and for its pro-gay policies for Disney personnel.

But here's the twist. In the months after Texas divested, Disney stock has fallen 30 percent. Republican school board member David Bradley says he feels vindicated. "We sold at the peak," says Mr. Bradley, from his office in Beaumont. "We were criticized by liberals that it was a social decision. But what we were looking at was the earning forecast from Oppenheimer and Bear Stearns, that took into account the power of that conservative boycott against Disney. What can I say? Buy low and sell high, folks."

The White House, however, hopes to stay clear of all these problems. There are a number of ways to minimize politics' influence of investment - from letting private firms do it to setting up a special board. Bureaucrats would not pick stocks directly. "Our intent is not to have the investment decisions made on a political basis," says White House spokesman Barry Toiv.

The head of Social Security, Kenneth Apfel, has said the Clinton administration wants to work with Congress to establish an independent entity that would oversee the investments. Mr. Apfel notes that the federal government is already making private investments for its pension programs and retirement savings available to federal workers.

Under Clinton's Social Security plan, $700 billion of the projected $4.4 trillion surplus that the White House anticipates in the next 15 years would be invested in the stock market. The president also wants to create individual savings accounts similar to 401(k) accounts, with Uncle Sam matching a portion of dollars saved for retirement.

"Clinton has moved the discussion forward, not back," says Barry Bosworth, senior fellow at the Brookings Institution in Washington. "I like individual accounts, but there is a problem with transforming Social Security from a strict pay-as-you-go program to more of a plan for savings. This does offer a way to go, and it will have a significant effect on the reform process."

As for states, many officials remain happy with what they have. Even when political pressure leads to a bad investing decision, good investments often outweigh the well-publicized bad ones.

For example, in 1991 the low point of Kansas's forced investment in local start-ups, the pension fund earned a meager 5.5 percent, but that was still above what it would have earned with bonds. Today, it is earning 17 percent, comparable with some of the nation's aggressive pension funds.

For the most part, those investing state funds say they try to make decisions based on financial considerations, not political ones. "Anytime we see political decisions weighing on the pension board of directors, we raise the red flag," Mr. Dahl says.