This week we’ve had the unseemly sight of leading public servants engaged in rank populism, publically demanding private companies prove their innocence of non-specific charges – and not in a court of law, but to the satisfaction of the “prosecutors” themselves, Adrian Orr and Rob Everett (with apparent encouragement from the Minister of Finance).  In the new Governor’s case, it wasn’t as if he’d even managed to keep to the same line from one week to the next: in interviews a couple of weeks ago he wanted us all to know that New Zealand was different and there wasn’t anything to worry about, but by this week he’d jumped on board –  perhaps not wanting to be left out –  with the chief executive of the Financial Markets Authority and was “demanding” answers from banks.

In the Governor’s case, the legislation he works under appears to give him no basis for such actions or demands –  his banking supervision powers are about the maintenance of a “sound and efficient” financial system, not about market conduct.   And independent central bankers –  overmighty citizens at present, with all that power in one man’s hand –  are well advised to stick to their knitting, the powers and responsibilities Parliament has specifically delegated to them.  Cheap populism is a dangerous path to take in pursuit of some faux legitimacy.    I’m much less familiar with the FMA’s statutory powers, but it is pretty unseemly to have public servants leaping into the public domain demanding that private companies justify themselves (with no specific charges or allegations) to them.   We are suppposed to be ruled by laws not by men, and just because Australian-owned banks aren’t overly popular in some quarters doesn’t exempt them from those precepts and protections.

Of course, the Governor and the FMA chief executive playing populism sets up its own equally unappealing set of responses.  The Bankers’ Association has published an open letter they sent back to Orr and Everett which is full of shameless pandering.  There was this

“Ultimately decisions about regulatory responses rightfully rest with you, and you have our commitment that we will support any response”


(a) none of this has anything to do with the Reserve Bank and the legislation it operates under,

(b) the FMA does not set its own regulations, but operates under legislation passed by Parliament and regulations promulgated by ministers,

(c) Royal Commissions, a la Australia, are entirely a matter for elected politicians, and

(c) no serious person is going to commit to support just any regulatory response, with no idea what form such responses might take.

There was also this

Proactive agenda of regulators: The New Zealand regulatory framework enables regulators to act dynamically and quickly before issues become significant, compared to the slower, less agile pace witnessed in Australia……We have also seen that foresign and adaptability in RBNZ’s use of loan-to-value lending restrictions, which proved effective in managing the escalating housing market and the associated economic risk.

Let me throw up now.

I’m still in the camp that thinks it inherently unlikely that matrix-managed subsidiaries of Australian parents are doing things that much differently here than in Australia (and, after all, the BNZ’s new chief executive has been part of the NAB Executive Leadership team for the last few years).  But evidence would be a good basis for regulators (those with suitable powers and responsibilities) to start inquiries, not highly-publicised populist fishing expeditions, and the associated slurs.  And evidence needs to go a bit beyond a suggestion that a bank might have suggested their Kiwisaver product to go along with your mortgage or cheque account –  akin to a burger chain encouraging you to consider fries with your burger.  If we must have populism, leave it to the politicians.  We can toss them out.

As I noted the other day, it isn’t as if the Reserve Bank and the FMA have been particularly good at dealing with specific conduct issues, on which they have detailed evidence.    The Reserve Bank’s misconduct –  and the passivity of the FMA –  doesn’t affect tens of thousands of people, but it doesn’t make it any more acceptable.  Perhaps it is a straw in the wind of the way many New Zealand institutions choose to operate?

After writing that post, into my email inbox popped the newsletter of that worthy NGO Transparency International.   Their website proclaims this mission

“A world with trusted integrity systems in which government, politics, business, civil society and the daily lives of people are free of corruption.”

The longserving chair of Transparency’s New Zealand arm is Suzanne Snively.  In this month’s newsletter she writes

The point of transparency and accountability is to strive to do the right thing in all activities.

New Zealand banks and insurance companies have been quick to distance themselves from the evidence found by the hearings before the Royal Commission.

The challenge is that New Zealand’s largest four registered banks – ANZ, ASB, BNZ and Westpac, are subsidiaries of Australia’s four largest banks. AMP is one of New Zealand’s largest insurance companies.

It is naive to believe that the New Zealand system is different without solid evidence. It is not enough to have the industry self-disclose. This after all, is what happened prior to the current Australian inquiry. Only through the process of independent scrutiny have we learnt what really is going on.


Based on evidence before the Commission that has to date been made public, much of the misconduct could be regarded as corruption. Corruption is the abuse of entrusted power for private gain.

The best antidote for corruption is the existence of strong integrity systems within organisations. An integrity system refers to the features of the entity’s structure that contribute to its transparency and accountability.

In high integrity organisations, transparency and accountability starts at the top, led by good governance supported by management policy and practice…….

New Zealand can own the leadership position and model good behaviour to the rest of the world.

Those are fine words.  So it is perhaps unfortunate that Ms Snively was closely involved in the abuse (misconduct at least) that I outlined the other day.

Back in the late 80s and early 90s, she was a Board member of the Reserve Bank.   Until the current Reserve Bank Act came into effect in early 1990, the Board was (in effect) the Reserve Bank –  all power and responsibility rested with them, and they delegated any powers they chose to the Governor.  After that, (in law) the Board assumed the current monitoring and accountability role.

The Bank’s Board had an active involvement in the reform of the Bank’s staff superannuation scheme (minutes from that era record substantive ongoing engagement).  Under the trust deed of the scheme, Board consent was required for any changes to the rules.   And a majority of the trustees of the superannuation scheme were either Board members themselves or appointed by the Board.  The then Governor was a trustee (ex officio), and so was Ms Snively.

And this  (extracted from the earlier post) was what happened in 1998, with Ms Snively serving as a Board member and trustee.

Suppose that the rules of a superannuation scheme explicitly required that any rules changes that could have an adverse effect on the interest of any member in that scheme could only be made with the unanimous consent of such members.

Suppose too that nonetheless the trustees of such a scheme went ahead and changed the rules of a defined benefit scheme in a way that allowed the employer to arbitrarily (ie no constraints at all) reduce the rate at which pension benefits were calculated (including in respect of periods of employment, and employee contributions, prior to the rule change).  No consent from potentially affected members was sought for this change.

Suppose that in making this change, they had the endorsement/consent of the board of directors of the employer, and of the chief executive of the organisation.

Suppose too that that new power was actually exercised by the employer, in a way which led to longstanding employees later retiring with pensions considerably lower than they would otherwise have been.  That represented a substantial wealth transfer (probably millions of dollars) to the employer.

It was an egregious abuse of power, and a betrayal of the trust responsibilities to members that all trustees had.

This wasn’t the only shady item during Ms Snively’s term as a government-appointed Board member, and as a trustee.   In 1991, a rule change was made to the scheme (not much more than a single line in a big package of changes).  It was done very late in the piece, with no consultation with members.   To this day, people argue whether it made anyone worse off, but under the law –  the Superannuation Schemes Act –  any rule changes were required to be advised in writing to members.  That simply wasn’t done.  It was an offence under the Act –  for which, fortunately for the trustees of the day, including Ms Snively, the statute of limitations has long since expired.  This point isn’t contentious: today’s trustees a few years ago issued a formal apology to members for that breach.

There is also reason to doubt that the rule change itself was ever properly made (consciously approved by the Board and trustees).  In fact, one trustee from that period has sworn an affadavit that he had no knowledge of the change (although he signed each page of the fairly-lengthy revised deed), suggesting questionable behaviour by Reserve Bank senior management.

Good governance when Ms Snively was on the Board and the trustees also appears to have involved the same law firm  (same lawyer) advising the trustees as was advising the Reserve Bank itself, despite the manifold potential for conflicts between the interests of members and those of the Bank.

These particular episodes occurred a long time ago (although, to the extent there was misconduct, the effects are still felt today –  that is nature of locked-in long-term retirement savings vehicles, one of the reasons there is a case for regulation).  And Ms Snively hasn’t been on the Board or a trustee for a long time.   But I understand that these issues were brought to her attention a few years ago, and she apparently displayed no interest in either getting to the bottom of them, or exerting the sort of moral suasion one might expect from someone who is head of Transparency International.

And it isn’t as if she is now completely detached from all things to do with the Reserve Bank.  A few months ago the new government appointed Ms Snively to head an Independent Expert Advisory Panel, listing as the first item that qualified her her former role as a director of the Reserve Bank.  She continues to play, apparently, a lead role in advising the government on the reform of the Reserve Bank Act, including the (rather large) chunks governing the Bank’s financial regulatory powers.

No doubt she has no legal powers or entitlements at this stage.  But part of leadership is a willingness to take a stand, to seek to exert some moral authority.  And particularly when you yourself are directly complicit in some institutional misconduct from years ago, all while now leading the cause of integrity in public life, one might have hoped –  perhaps might still hope? –  for more.  Integrity sometimes involves going the second mile; it isn’t just a matter of systems, processes, and bureaucratic procedures, or the attempted cover of “oh, I’ve moved on”.

Much the same might be said of today’s Reserve Bank Board.  They appoint a majority of the trustees, they appoint the chair of trustees, they have to give consent to any rule changes.  Until 2013 the then chair of the Board served as a trustee.  They are fully aware of all these issues, and until very recently the Governor himself served as a trustee.  But the Board seem to have seen their role as providing cover for the Governor, rather than ensuring that the right thing is done, and that past abuses are corrected, not kicked for touch, hoping the injured parties would just go away.   That sounds like the sort of misconduct –  not illegal, but not the sort of approach we should expect from ministerial-appointed people, explicitly there to hold management to account –  the authorities might make a start on.  There is, after all, something concrete to go on there, even if it doesn’t make such good headlines.

Perhaps the Reserve Bank (and the FMA) should heal themselves

Suppose that the rules of a superannuation scheme explicitly required that any rules changes that could have an adverse effect on the interest of any member in that scheme could only be made with the unanimous consent of such members.

Suppose too that nonetheless the trustees of such a scheme went ahead and changed the rules of a defined benefit scheme in a way that allowed the employer to arbitrarily (ie no constraints at all) reduce the rate at which pension benefits were calculated (including in respect of periods of employment, and employee contributions, prior to the rule change).  No consent from potentially affected members was sought for this change.

Suppose that in making this change, they had the endorsement/consent of the board of directors of the employer, and of the chief executive of the organisation.

Suppose too that that new power was actually exercised by the employer, in a way which led to longstanding employees later retiring with pensions considerably lower than they would otherwise have been.  That represented a substantial wealth transfer (probably millions of dollars) to the employer.

And suppose that the Government Actuary had been required to give consent to such a rule change, and in fact did so.

That looks to me a lot like serious misconduct, quite possibly illegality.

And who are the players in this tawdry drama?

Well, there was the Government Actuary, a task now absorbed by the Financial Markets Authority.

And there was the Reserve Bank of New Zealand, its Governor (appointed by the then Minister of Finance), and its Board (all appointed by the then Minister of Finance).  Serving on both the board, and the trustees of this superannuation scheme, was the Governor, and someone who is now chair of the New Zealand arm of Transparency International, an NGO allegedly committed to good governance etc.

The initial misconduct happened quite long time ago.  In 1988 in fact.    But for years now some members have been trying to get redress, and even recognition of the problem.  It has been going for sufficiently long that when Adrian Orr was last at the Bank –  as Deputy Governor and Head of Financial Stability –  he was involved, fobbing off concerns raised by some of his own staff.

Four years ago, a particularly persistent member formally raised the issues (the one I’ve outlined here isn’t the only example, although is probably the most serious) with the trustees of the superannuation scheme.  The initial response of the Board-appointed chair (and current Deputy Governor and Head of Financial Stability) was to attempt to close the issues down immediately, without undertaking any investigation. I guess if you don’t turn over stones, there is no risk of finding awkward stuff under them.  Fortunately, other trustees stymied that bid.

After a couple of years’ delay, the trustees somewhat reluctantly came to the view that probably member consent should have sought, and that the decision not to have done so was not necessarily one they themselves would today have made.  But………they weren’t going to do anything at all about rectifying the situation, claiming (on grounds almost totally without foundation) that no one had actually been adversely affected.  These are trustees who, by common law and now by statute, are required to operate in the interests of the members of the scheme (beneficiaries of the trust).  But who could easily have been misinterpreted as operating in the interests of the Reserve Bank (a majority of trustees appointed by the Reserve Bank Board –  the entity that has spent the last few decades providing cover for Bank management).  Under the (relatively) new Financial Markets Conduct Act, superannuation schemes are now required to have an independent trustee –  the one on the Reserve Bank scheme (whatever his other useful contributions) declared early on that he had no desire to be caught in the middle trying to sort out such difficult issues, and (from my memory) has barely uttered a word in all the debates since about these issues.

And what of the FMA?  It is now must be almost a couple of years since the member elevated the issue to the FMA, lodging a formal complaint with them.    And since then the FMA appears to have done almost nothing (there was a meeting with the trustees well over a year ago, but it involved little more than description of the issue –  and at the time the FMA themselves didn’t even seem to have a good grasp on their own act).   Perhaps it is typical for the FMA?  I don’t have anything else to do with them, so have no basis for knowing.  Perhaps there are legal constraints (old legislation) on their ability to actually do anything formally.  But there has been no informal action, moral suasion, either.   Indeed, their inaction could be easily be misinterpreted as having something to do with the fact that the organisation itself (as the Government Actuary) had signed off on the, almost certainly unlawful, rule change.  And perhaps too from the sheer awkwardness of having to investigate serious concerns about an entity associated with their fellow regulator, the Reserve Bank, an entity then chaired by someone who is now Head of Financial Stability (Bascand is no longer the chair, but is still a trustee).  Or from signs that the independent trustee regime they administer seems to be adding only overhead.

I don’t want to bore readers with the details of this particular tawdry episode.

But when we have the new Governor  –  with legislative responsibility only for prudential issues –  lurching from two weeks ago suggesting there were no particular conduct issues in New Zealand, because we had a quite different culture, to last week suggesting that it really wasn’t his call (on an inquiry) but he was sure banks were examining themselves, to news this morning that he and the FMA head had summoned the heads of the big banks to a meeting, demanding they prove a negative (that there is no “misconduct” going on), and (in the FMA head’s case) apparently threatening legal action against those who don’t cooperate, I could only think

Physician heal thyself

or continuing the biblical theme

And why do you look at the speck in your brother’s eye, but do not consider the plank in your own eye? Or how can you say to your brother, ‘Let me remove the speck from your eye’; and look, a plank is in your own eye? Hypocrite! First remove the plank from your own eye, and then you will see clearly to remove the speck from your brother’s eye.

(As background, I am both a member and an elected trustee of this superannuation scheme. I have recorded in the minutes my dissent from the majority view of trustees, and have expressed my own concerns directly to the FMA.  As I joined the Bank, and the scheme, not long before this particular questionable rule change was made, it probably did not materially adversely affect me.)

A depressing debate

Watching last night’s party leaders’ debate had its entertaining moments, but mostly if it  was clarifying it was so in a pretty depressing way.    And one of these two will be Prime Minister for the next three years.

There was the sight of both party leaders falling over themselves to disavow any notion that house prices should fall.  Apparently, a $1 million average house price (or the less headline-grabbing but still obscene median price of $800000+) in Auckland is just fine.  I suppose we should be grateful that on the one hand the National Party has moved on from the nauseating talk of how these house prices were a “sign of success” or a “quality problem”, and on the other hand that Labour’s housing spokesman will openly talk of an aspiration to having house prices averaging perhaps 3 to 4 times income.    Perhaps both party leaders really would prefer that Auckland house prices hadn’t increased very substantially in the last five years, but now they both seem content to simply treat it as a bygone –  as if we should simply live with $1 million house prices indefinitely until, some decades hence, a combination of inflation (mostly) and real income growth, might render home-owning in our largest city once again affordable to new entrants.

A couple of weeks ago I showed this chart.  Starting from a price to income ratio of 10 –  roughly that in Auckland now –  it traces out how house price to income ratios would evolve if nominal house prices were unchanged from here on (something both party leaders now appear regard as a good outcome).

house price to income ratio with flat nominal house prices

Just focus on the green line.  If we have inflation averaging two per cent, and productivity growth matching the performance of the last 30 years (quite a step up from where we are now) it would take almost 25 years to get price to income ratios down to even around five times income.     The Prime Minister talked of this being an issue for his kids.  The solution, to the extent there is one, seems to be aimed at his grandchildren.

Ardern seemed to try to have it both ways with the talk of “we just need to build more affordable houses”.   Lay members of my household responded “well, wouldn’t building more houses lower prices, which she just said she didn’t want?”.     Actually, it is unlikely to make very much difference, unless she is serious about freeing up land supply.  Without that, the overall affordability of the housing stock won’t change much, and any new houses built by or for the state will largely displace others that would have been built by the private sector.  And yet, although on paper Labour’s policy on improving land supply looks promising, the current Leader of the Opposition continues in path trod by her predecessor and simply never mentions the land issue –  even though everyone recognises that in Auckland in particular, the price of land is the largest component of a house+land.   Relative to that, further extending capital gains taxes is just a third order distraction.   At any plausible rate  –  in today’s low interest rate environment –  so is a land tax.

Sadly, I suspect there is an element of dishonesty about both party leaders’ responses.  If their housing policies really worked, I can’t imagine that either one would have a problem if house prices fell by, say, 20 per cent all else equal.  That alone would lower price to income ratios in Auckland to eight times.    It seems unlikely that that sort of fall would put anyone much in severe financial difficulty –   not that many people recently have been able to borrow at LVRs over 80 per cent anyway, and servicing capacity mostly depends on continued employment.     Continuing to talk of stable nominal house prices perhaps avoids (a) scaring the many people whose equity would be wiped out if house prices fell by 50 per cent, and (b) leaving themselves open to scare stories about how falling houses inevitably mean terrible economic times.   But it also makes a hard to develop a constituency for the sort of changes that might, in time, make a real difference, and enable this generation of young people  –  ordinary working families – to afford a decent home.

If that was bad enough, Jacinda Ardern’s superannuation pledge was worse.    John Key’s  pledge to resign rather than increase the NZS eligibility age was cynical –  he was quite open to Treasury that the age would rise, just not under his watch – but perhaps almost understandable in the context of the 2008 campaign.   Helen Clark would have run the “secret agenda to raise the age” line, at a time when Labour itself had no intention of raising the age, and had established the NZSF to buttress the political messaging.   But in this election, the incumbent Prime Minister leads a party which intends to legislate to increase the NZS age –  by a little, and some decades down the track.  It could hardly attack Labour for leaving open the possibility.   Even if Labour didn’t want to increase the NZS age itself now, what would have been wrong with a simple pledge that “no, we don’t see a need to raise the NZS age at present.  I don’t envisage it happening, but if at some point that judgement changes, I pledge that we won’t change the age without taking it to the public first as an election campaign promise”?

When the Prime Minister announced his NZS policy back in March, I ran this chart

Here is a chart showing life expectancy at 20, and the NZS eligibility age.  The final two dots are what might have happened by 2040 if the life expectancy gains continue at the same rate as since 1950, and the NZS eligibility age if yesterday’s National Party policy proposal comes to pass.

life and NZS age

Over that full period, 90 years, the NZS eligibility age would have risen by two years, and adult life expectancy (those getting to 20) would have increased by about 13.5 years.  By 2040 it will be amost 40 years since the NZS age got back to 65.  In that time, adult life expectancy is likely to have risen by 5 to 6 years, and yet the NZS age will have risen only by two years, if the new National Party policy is implemented.

How has a New Zealand politics got so febrile that parties that claim they want to use scarce fiscal resources to solve child poverty are reduced to this?   We can be pretty sure Bill English won’t be Prime Minister in 2037, so the NZS age won’t actually increase on his watch –  he’ll just foreshadow change decades down the track –  so in effect both candidates to be Prime Minister are refusing to increase the age while they are PM.   Old people vote of course, but this isn’t an issue about today’s old people –  it is about today’s middle-aged and younger people.   Even among today’s older people, almost half of those aged 65 to 69 are still in the labour force.

partic rate 65 to 69

Personally, I support a modest universal age-pension, but not one that cuts in at an age when a huge proportion of the recipients are still working, and are physically capable of doing so.    And how come we can scarcely even have that political debate even though all manner of other advanced countries have been willing to take steps to increase the eligibility age?  In Australia, for example, the age pension eligibility age will be 67 by 2024 –  and technically, all those Australians, and (a more plausible possibility) the New Zealanders living in Australia, would be eligible to relocate to New Zealand and claim our NZS, with no prior residence requirement, at age 65.

I found the “debate” around child poverty almost as depressing.    Neither party is actually willing to campaign for lower house prices –  even though housing costs have been a big factor in the material and financial challenges some face.  And all the talk was of how much money (other people’s money) the government could throw at the problem, with no mention at all of the possibility that improved economic performance might be the best way to lift living standards for everyone.  But then neither party seems to have  a serious idea as to how to lift our economic performance –  or even to care much about doing so (the Prime Minister just makes up stuff about the current performance of the economy).   And the Prime Minister was very keen to talk up how he, lots of data, and some public servants, are going to solve all manner of social problems.  Which, on the one hand, displays a touching faith in the capability of politicians and bureaucrats –  usually shared only by politicians and bureaucrats, and with little in past experience to support it –  and on the other simply refuses to address the likelihood that cultural factors are part of the story in dysfunction and deprivation.    I don’t really expect it from today’s Labour Party, but the Prime Minister is a self-described social conservative.

And then there was the wages debate.  On that one, I reckon the Prime Minister is right on the facts –  real wages have been rising, and faster than productivity has –  and I was disappointed to see the Leader of the Opposition still running here “its how people feel that matters”.   It might be uncomfortable to face it but wage inflation running ahead of productivity (and even than terms of trade gains) is one of the symptoms of an overvalued real exchange rate.  Plenty of observers –  including the outgoing Governor –  have highlighted that as a serious challenge for New Zealand.  It is part of the reason why Treasury forecast that exports will be shrinking as a share of GDP on current policies.   (If this whole point is obscure, it is partly a teaser for a forthcoming post.)

UPDATE:  On further reflection I’ve deleted the final paragraph.  I wrote it based on reading various commentaries, but before digging into the numbers myself (a salutary lesson that I shouldn’t need).   Understanding better both the Labour numbers and the National claims, I’d now take a more nuanced stance.

And, of course, there was the $11 billion fiscal hole that wasn’t.   Perhaps the National Party really believed their story when they put it out yesterday morning. By debate time, it was pretty clear to anyone without an axe to grind that there was little or nothing there.     Wouldn’t an honourable Prime Minister have simply quietly let the issue slide, and addressed the real challenges New Zealand faces, including real and legitimate questions about his own government’s performance over nine years, and about the aspirations and specific proposals the Labour Party is now outlining.

Time to wind-up the NZ Superannuation Fund

In their print edition last Friday, NBR ran a piece from me suggesting that it was now time to wind-up the New Zealand Superannuation Fund.  For those with NBR subscriptions, it is now available on line.

I didn’t assign my copyright to NBR or anything of the sort, but I won’t reproduce the full column here.  It was, largely, a much shorter version of a post I did here a couple of weeks ago (and in the process of generating it, I proved to myself again that one reason I write long posts is that short posts take much longer).  But this was the final paragraph.

There is a political debate to be had about both NZSF and about the future parameters of New Zealand Superannuation.  But the two simply aren’t very logically connected.   What NZS policy we run in future depends on all manner of things, including the overall state of the government’s finances.  But the performance of one part of the balance sheet simply isn’t a key consideration.    If it makes sense for governments to run speculative investment management operations, it does so whether or not life expectancies are increasing.   But short of Norwegian quantities of oil and gas being discovered here –  which give the government cash that simply has to be invested –  it is just isn’t a business the government should be in.  Fortunately, the Fund hasn’t done badly over its life to date, but let’s bank the gains, and wind-back the considerable future risks by closing the Fund and using the proceeds to repay government debt.   

In both my recent posts on NZSF (here and here) , I’ve tried to emphasise that those who run it probably haven’t done a bad job in the time they’ve been managing our money.  (Here I should note that the NZSF have pointed out, via a response to someone else’s OIA, that in my first post I made a mistake in annualising the rates of return on the New Zealand stock exchange, a number I had mentioned in passing in that post.  NZSF and I agree –  on this if little else –  that the New Zealand stock returns are not a particularly meaningful benchmark for these purposes.)

NZSF has been charged by Parliament with running a high risk fund, they’ve done that, and over a period in which global asset markets have done rather well, they’ve made quite a bit of money for the taxpayer.  But if the relevant benchmark isn’t the NZSE50, neither it is (as NZSF and its chief executive keep claiming) the Reference Portfolio that the Fund Board themselves construct and adopt.  The latter has some uses inside the organisation, but it is largely irrelevant for taxpayers and citizens trying to decide whether NZSF has (a) done a good job, and (b) should exist at all.

In their own official documents, the relevant performance benchmark is

It is our expectation, given our long-term mandate and risk appetite, that we will return at least the Treasury Bill return + 2.7% p.a. over any 20-year moving average period.

That expectation is hardly ever mentioned when, for example, the chief executive takes to the media.  It didn’t appear in the OIA response I linked to earlier either.

As it happens, the returns to date have been (quite a bit) better than that benchmark –  which is why I’m quite open about the fact that NZSF has probably done a reasonable job, perhaps as good as most other managers with their opportunities might have done.   But after only 13 years, their own official documents tell us that we can’t yet know how much of those returns is down to luck, and how much down to skill.   As they note, when you take as much risk as they do –  really big year to year fluctuations –  it takes a long time to tell.   When global markets are rising strongly it isn’t hard to make money.

Over the life of the Fund, their total returns have averaged around 10 per cent per annum.  As I’ve noted previously, over most of that period the Treasury required government agencies looking at investment projects to use a discount rate of 8 per cent real (or around 10 per cent in nominal returns).  Of course, what discount rate one should use depends on how risky the proposed project is, and what it does to the risk profile of the whole of the owner’s business.  A “high octane” (Orr’s words) investment management subsidiary is risky –  it might not be Wellington aiport runway extension risky or INCIS risky, but it will be riskier than, say, a new school in a growing city.   And these sorts of investment management returns tend to add to, rather than reduce, the variance of the Crown’s overall financial position –  in particular, the biggest losses tend to become starkly apparent in periods when there is the greatest pressure on other government finances (ie in severe global economic and financial downturns).  A 10 per cent (pre-tax) return over the period from 2003 to now –  even though it is better than they expected –  just isn’t that impressive.  And NZSF tell us that even they believe those sorts of returns can’t be expected to be replicated in future –  they tell us we should expect 2.7 per cent above the Treasury bill rate.  Who knows what a “neutral” New Zealand Treasury bill rate is, but even if it is getting up to around 4 per cent, that suggests expected future pre-tax returns of less than 7 per cent.   And there is no reason to think that the variances, or covariances, of the portfolio will be less in future than they have been.    (In recognition of the lower interest rate environment, Treasury now encourages government agencies to use a real pre-tax discount of 6 per cent –  or 8 per cent in nominal terms.)

I could add into the mix the point that few private companies will be using hurdle rates of return of less than 10 per cent in deciding on investment projects, or the acquisition of a subsidiary.  And that is what NZSF is –  a fairly aggressive investment management subsidiary of the New Zealand government (with deteriorating governance/transparency –  eg when a large chunk of a government-owned local retail bank is in the portfolio).

And so my bottom line is that we should be thankful for the reasonable returns we’ve had from NZSF to now (through some mix of luck and skill), but that since we can’t count on anything like those sorts of returns in future (even NZSF say so), and even the returns to date are really only sufficient to compensate us for the risk run on our behalf, we’d be better off locking in the gains we’ve had, closing down the Fund,  liquidating the assets over a couple of years, and using the proceeds to repay public debt.    Our government does not need to be in this game –  unlike, say, the governments of Norway or Abu Dhabi, with genuine wealth to manage and smooth –  and the returns to doing so don’t look that attractive.   As the Crown is already heavily exposed (both through the tax system and its other extensive asset holdings) to the ups and downs of the domestic economy and global markets, strategies that reduce risk, rather than increase it, seem intuitively more appealing.  The NZSF logic is the opposite of that.

To accompany my NBR piece, they did an NBR Radio interview.  The one question that got me thinking –  and really the reason for this post, which to some extent is traversing old ground –  was along the lines of “wouldn’t winding up the NZSF leave ordinary people worried about whether their NZS pension would be there for them when they got old?”.

That the question slightly rattled me probably just reflected the fact that I’m a macroeconomist not a political scientist.    Perhaps it is also a testimony to Michael Cullen’s political skill in constructing the NZSF, initially to safeguard surpluses from spending ministers as anything else, and linking it to the NZS regime.      But why shouldn’t people worry?

  • NZSF is only a small part of the government’s overall balance sheet,
  • Our government finances are –  thanks to a succession of Labour and National led governments –  among the stronger in the advanced world,
  • Even the staunchest advocates of NZSF never saw it contributing more than a moderate proportion of future NZS costs,
  • We’ve had a universal government pension since around 1940 –  with brief interruptions in the means-testing years of the 1980s and 1990s – and a government old-age pension for those in need since 1898,
  • Our universal old-age pension is high enough to keep most old people out of poverty (even those who earned low enough incomes through their lifetimes that they’d have had little effective capacity to save), but doesn’t (of itself) deliver high incomes to people beyond basic needs (so it isn’t like some state schemes elsewhere in the OECD),
  • And there is nothing about NZS that is unaffordable in the long run, provided that sensible, well-foreshadowed, adjustments in the age of eligibility are made, in line with continuing improvements in life expectancy.  Ideally, we’d have the age at 67 already, and be increasing (by statutory formula) a little each year as the life expectancy rises.   Simply shifting the age to, say, 67 doesn’t resolve the issue, but a suitable resilient formula-based adjustment would.

In modern times, the greatest period of uncertainty –  by far –  about future state pension support was during the years from around 1985 to 1998 when a means-testing regime was instituted and then constantly revisited.  That had to do with some combination of the overall stretched state of the government’s finances, as well as essentially ideological debates about universality vs targeting.

If one believes –  as I, somewhat reluctantly (but for good second-best reasons) do –  in a modest but universal state age pension, the best protections of that over the long-term, and the best way to provide predictability to individuals (avoiding jerky discontinuous policy adjustments) are

(a) sound overall government finances (low debt levels, and tax and spending shares of GDP that don’t push historical or international limits), and

(b) agreed, or at least broadly accepted across the main parties, statutory provisions that lay down well in advance how the age of eligibility will adjust in future as life expectancy increases.

NZSF really isn’t relevant to either.    It is just a high-risk investment management business, and that isn’t a natural business of government.

And veering slightly further off topic, I’m still puzzled by that Labour-Green commitment I discussed yesterday to keep core Crown spending to around 30 per cent of GDP while doing nothing to alter NZS parameters.  This was the chart from the Treasury’s long-term fiscal statement released late last year.

ltfsThey would be okay for the next few years, but once you get even 10 years out from here, there would need to be a lot of other expenditure cut to keep spending to around 30 per cent of GDP, even if (a) the two parties resume NZSF contributions soon, and (b) investment returns proved to be pretty good.   I’m genuinely puzzled how they propose to square that circle.

Defenders of the NZSF

After the flurry of coverage a couple of weeks ago over the remuneration of Adrian Orr, chief executive of the New Zealand Superannuation Fund, debate seems to have turned towards the more substantive issues around the role of the Fund.   The chief executive has been out, in his usual feisty and rather opportunistic style, defending the Fund, advocating for it to be given more money to invest and so on.   One could reasonably question whether the latter in particular is the role of a public servant.  His job, surely, is to invest the money the government has chosen, under the terms of the legislation, to place with NZSF.    Wisely, in my view, no more money has been placed with Fund since 2009 (although even then I thought it was shame the government didn’t simply wind up the Fund).  But this is now an election campaign issue, with the Labour Party vocally calling for an immediate restart of contributions.   That is perhaps understandable from a party which now, once again, favours keeping the NZS age at 65 indefinitely –  which was pretty much their position back when the Fund was first set up.   But it is a debate senior public servants shouldn’t be participating in in public.  Whatever one’s view of the NZSF itself, there are simply fewer grounds for it if one thinks the age of NZS eligibility should be increased over time, as life expectancy improves.

What has also interested me is the vocal support Orr has had from various journalists. In the Orr interview I listened to, on Radio New Zealand’s Nine to Noon on Monday, Kathryn Ryan seemed to see her role as being to help Orr get “the truth” across, cheering him on as he went, rather than asking any searching or challenging questions.  And this morning, in the Dominion-Post, Vernon Small is channelling the Orr lines, but in even more strident tones.  He concludes that we’d be “barking mad” not to be putting more money into the NZSF each and every year.

Well, perhaps. But Orr in particular was guilty of downplaying quite a lot of important considerations.

First, for all the breathless excitement about the NZSF’s investment returns (around 10 per cent per annum, pre-tax, over the life of the Fund), there has been no hint from chief executive, or his media supporters, of the rather more disciplined approach official NZSF documents, presumably adopted by the Board, take:

It is our expectation, given our long-term mandate and risk appetite, that we will return at least the Treasury Bill return + 2.7% p.a. over any 20-year moving average period.

By design, it is a highly risky Fund (“high octane” was Orr’s description) and performance can only seriously evaluated over quite long periods of time –  20 year periods in the organisation’s own telling.  But Orr (or Ryan or Small) didn’t make that point.

Kathryn Ryan’s breathless praise of the investment performance included, a couple of times, “even over the global financial crisis”.     That period was certainly pretty dramatic, but for equity markets it just doesn’t look that unusual in the longer sweep of history.  Here is a chart of the S&P500, in real terms and on a log scale.

sp-500-historical-chart-data-2017-03-15-macrotrends (1)

The fall in equity prices over 2008/09 looks like the sort of fall one might expect every 15 or 20 years –  and that one was shorter-lived than most.  If you take lots of risk in equity and bond markets, the last 15 years haven’t been a hard time to make money.  As far as I can see, the NZSF has more or less been compensated for those risks (it has forced us citizens to bear) but no more than that.  (I was however amused by the shameless attempt of the Fund’s head of asset allocation, in response to a recent OIA request, to suggest that returns from January 2009 –  near the trough of global markets –  was a meaningful number to use in evaluating the Fund’s performance.)

So the problem with the Fund isn’t that its investment management choices (both those they would loosely classify as “passive” and those equally loosely classified as “active” –  the distinction is pretty arbitrary) have been particularly bad, or good.  They’ve probably been about what one might reasonably expect over that period.  And if we closed the Fund now, or shifted all the money back to low-risk assets, we could crystallise the gains and be thankful that, despite all the risk run, we made money rather than lost money.     But nothing in the Fund’s investment strategy will protect taxpayers if, and when, markets turn bad again.

Orr continues to misrepresents the NZSF as a “sovereign wealth fund”.  It simply isn’t.  We aren’t Norway or Abu Dhabi, managing for an intergenerational perspective, oil wealth that has been turned into cash.   All the money put into the NZSF has either been raised from taxes or borrowed.     There isn’t a pool of money that naturally needs investing.  Rather, the government has established a high-risk investment management subsidiary to punt on world markets.     That simply isn’t –  and never has been –  a natural business of government.

The Fund itself doesn’t have to worry where its money comes from.  But citizens do.   Who knows what governments would have done with the money if the NZSF had never been established.  I suspect much of it would have been wasted on increased government spending.  But it would have been possible to have cut the most distortionary taxes –  those on business income –  quite heavily, which would probably have given risen to a lot more business investment in New Zealand.  None of the analyses of the returns of the Fund ever seem to take into account, for example, the deadweight costs of taxes.  On mightn’t expect NZSF to do so –  they are just investment managers –  but if they don’t they aren’t really in a legitimate position to be calling for more public money to be steered their way.

Orr cites a number of other advantages for the Fund.   He argues that it has contributed to developing New Zealand capital markets.  I’d be interested to see the evidence for that claim.  Most of the Fund’s assets are invested abroad, by intentional design.   What would New Zealanders have done with money if they’d had it as individuals?   And I don’t quite see how sweetheart inside deals, whereby ACC and NZSF  – neither with any particular expertise in retail banking –  take chunks of Kiwibank from NZ Post, enhance New Zealand capital markets.  No doubt having a hulking behemoth (by New Zealand standards) like NZSF generates more activity –  NZDMO got to issue more bonds than otherwise, and then NZSF buys more (mostly overseas) assets –  but are the capital markets really better –  and by what standards – for the presence of the Fund?

I also heard him argue that the NZSF somehow reduces risk and improves certainty. I wasn’t quite sure what he was referring to, but it seemed to be about the future of NZS itself.    But again, he is really talking beyond his pay grade.  The future of NZS is a political issue that really has little or nothing to do with the NZSF size/performance.   It isn’t like a contractural funded defined benefit pension scheme.  Presumably the overall state of government finances, overall tax burdens, and a community consensus on what is fair and reasonable are more likely to shape the future of NZS than the presence (and investment returns) of NZSF.    And in thinking about the overall government balance sheet –  something Orr doesn’t seem to, and isn’t paid to, think much about –  NZSF is currently only about 10 per cent of total assets.

He is on similarly shaky ground when he talks about save as you go approaches beating out pay as you go approaches.  I’m sure we can all agree that saving for the future typically makes sense –  the power of compound interest and all that  –  but that insight doesn’t help at all in deciding what, if any, role NZSF should have.   After all, we could wind NZSF up today, use the proceeds to repay government debt, and nothing would change about accumulated public sector savings.  Higher public sector savings is mostly a choice between taxing more and spending less.   As it is, I’d probably be happier if overall government net debt (including NZSF assets) was quite a bit lower than it is (ie build up government savings a bit more), but at least until all the gross government debt is repaid the government simply doesn’t have to be in the financial investment management business –  it is a pure discretionary choice.    We haven’t been there so far in the 14 year life of the Fund, and it doesn’t look likely that we will be in the next few decades either.  And Orr gives no weight at all to the failures of government, which often see additional Crown revenues wasted rather than saved.

Orr, and his defenders, have also been keen to scoff at any analogies with how a household might approach decisions.  I heard him say something along the lines of “if governments could act like households, we wouldn’t need governments”, which is true, but irrelevant in this context.  One role governments play, on behalf of households collectively, is to absorb collectively some of residual risks that individuals aren’t well-placed to handle.  That might tell you that often governments can’t, or won’t or shouldn’t cut spending in severe downturns, because some of their obligations increase then (and they are willing to let automatic stabilisers work).  For that reason, governments should be wary of revenue sources, or investment returns, that are very highly positively correlated with the economic cycle.  For example, one reason to be wary of capital gains taxes is that they tend to flatter government finances in good times, only for the revenue to dry up just when governments need it most (see Ireland last decade for a classic case study).    The same might well be said of highly risky asset portfolios –  even if they do quite well over the very long haul, they will look particularly poorly at just the times when government finances are under most pressure for other reasons.  In fact, if the pressures get serious enough, governments might come under pressure to liquidate those risky holdings right at the bottom of the cycle.  Those aren’t issues Orr has worry about –  he is simply paid to maximise returns on his little chunk of government resources, subject to acceptable risk –  but citizens, and people worry about overall government finances through time should do.

After all, it is not as if governments don’t already have other income and investment returns that are quite tied to the economic cycle.  Even on the investment front, for good or ill the government has quite large commercial holdings (those SOE stakes), and on the revenue front the tax system effectively makes the government an equity stakeholder in every business in New Zealand.

Orr and his defenders also scoff at household comparisons because, so they note, the government can borrow more cheaply than households.  More flamboyantly, here is Vernon Small’s take

As a comparison it may be politically effective but it is about as useful as a chocolate teapot.

Show me the household that can tax, has a central bank to set interest rates and biff around the exchange rate paid at the corner dairy, can borrow more cheaply than any business at rates below any mortgage offered by banks – and can live on for decades past the final days of its family members – and I’ll show you the household that has much to learn from a central government or vice versa.

Actually, the typical government (as distinct from the idealised one no one has ever seen) has operated with a horizon considerably shorter than that of most households.  And that is understandable:  I care about my kids and potential future grandchildren, who will still be there in decades to come.  Politicians –  who run governments –  face elections quite frequently, and in the course of a single lifetime successions of them run policy all over the show.

And quite how do people think that governments borrow so cheaply?  Because they have the power to tax, and that power is mostly exercised not over random stateless aliens, but over New Zealand households.  Every debt the New Zealand government takes on involves risks for New Zealand households – risks that at times of stress, governments will disrupt household and business plans by unexpectedly making a grab for a larger share of our incomes/wealth.  That risk limits the other risks households can afford to take, and is why I keep stressing that an accountable government can’t think of the cost of funds as simply the government bond rate; it has to price the implicit equity, bearing in mind that the coercion involved in the power to tax is more costly and distortionary than (say) a large company having to issue new debt if times get tough.    People like to say that governments can’t (usually) go bust, and so are subject to fewer “bankruptcy constraints” in thinking about undertaking possible long-term activities –  but that is typically true only to the extent that they ignore the perspectives and finances or their citizens, who ultimately bear the risks.  Ignoring citizens isn’t what governments are supposed to do.

My bottom line remains that NZSF hasn’t done badly what it has been asked to do (if you want a high risk fund that is).  Equally, it hasn’t really been put to the test.  They probably made some quite good calls at times, but the risks they assume for the taxpayer are very considerable.  In that OIA response I referred to earlier, they attempt to rebut some of my arguments, by suggesting that the appropriate hurdle rate of return should depend on the riskiness of the project.  I read that and thought: “yes, and that is really to concede my point”.    Over the life of the Fund, the standard deviation of annual returns has been almost 13 per cent.  Those are really large fluctuations –  by design –  and in considering establishing (or retaining) a government leveraged investment fund –  effectively a business subsidiary of the government – taxpayers need a lot of compensation for that risk.    Especially as that risk –  in the extremes, which are what matter –  is pretty correlated with other risks to government finances directly, and those of household sector finances indirectly, so there isn’t much –  if any –  overall risk reduction taking place.   When typical Australian companies uses hurdle rates in excess of 10 per cent, we shouldn’t be that comfortable  in our government running such a risky investment management operation for returns that, over a good 14 years, have only just matched 10 per cent.  I’m not suggesting anyone could have done much better than NZSF managers have, just that it wasn’t worth doing at all, evaluated by the sort of standards firms and households apply to their own finances.     And all that on a Fund that at present is only around 13 per cent of GDP.   The risk dimensions of the Fund become even more important if contributions are resumed and we envisage a Fund that could become a much larger component in the overall Crown balance sheet.

There is a political debate that should be had about NZSF.  There is a debate to be had about the future parameters of NZS.  But the two aren’t really very logically connected –  despite the words in the legislation.  If speculative investment management is a natural function of government, it is so regardless of baby boomers ageing, life expectancy or the parameters of any element of the welfare system.  Short of New Zealand discovering Norwegian quantities of oil and gas, I suspect it is no appropriate business of government.






New Zealand Superannuation Fund: does it pass commercial tests?

There has been a great deal of coverage in the last few days of the New Zealand Superannuation Fund, all prompted by the news that the chief executive, Adrian Orr, had been given a substantial pay increase by the Fund’s Board, over the objections of the State Services Commission and the then Minister of Finance.

I don’t have a strong view as to how much the chief executive should be paid.  In general, I also don’t have a particular problem with that amount being determined by the Board, without ministerial involvement.  Then again, this is simply a body managing a large pool of (borrowed) government money, and I couldn’t see a particular problem if the relevant Act was to be amended to make the terms and conditions of the chief executive a matter determined by the Minister of Finance, or the State Services Commission, perhaps taking advice from the Board.   After all, that is exactly the model that applies for the Governor of the Reserve Bank.

Amid the recent media coverage, there has been a lot of hyper-ventilation about the performance of the Fund, and of Orr himself.  In his Dominion-Post article, Hamish Rutherford reports that

One commentator suggested if Orr had achieved such a return in New York he might have made a billion dollars.

That seems unlikely frankly.   Orr simply isn’t –  and I wouldn’t have thought he’d claim otherwise –  some investment guru, blessed with extraordinary insights into markets, prospective returns etc etc.  He was a capable economist, and a good communicator (at least when he doesn’t lapse into vulgarity), who turned himself into a manager and seems to have done quite well at that.   He always seeemed skilled at managing upwards, and his management style (in my observation at the Reserve Bank) seemed to err towards the polarising (“are you with us, or against us”), attracting and retaining loyalists, but not exactly encouraging diversity of perspectives or styles.  He isn’t exactly a self-effacing character. (That is one reason I’m not convinced he is quite the right person to be the next Governor of the Reserve Bank.)

The New Zealand Superannuation Fund has made money, both before and since Orr took over a decade ago.  Of course, amid a trend increase in global asset markets it has been hard not to.   The NZSE50 gross index, for example, has increased at an annualised average rate of about 9.8 per cent per annum since 1 September 2003 (when the NZSF opened its doors).

As for how good the NZSF have been, it is probably too early to tell.  Don’t take my word for it: here is how they themselves put it

It is our expectation, given our long-term mandate and risk appetite, that we will return at least the Treasury Bill return + 2.7% p.a. over any 20-year moving average period.

The Fund has now been operating for only about 13.5 years.  In some respects, the returns to date look quite good –  they’ve averaged 5.6 percentage points per annum above the Treasury bill return –  but for a Fund with the sort of risk parameters they have adopted one can only really evaluate performance over very long periods.  And global asset returns have been pretty attractive over much of the last 15 years.  Will that be repeated?  Will there be a big sustained correction?  The only honest answer is that no one knows.  (And the 20 year time horizon is probably a reason why the institution’s CEO shouldn’t be remunerated to any significant extent on some investment performance formula –  unless there are clawbacks built in for the next 20 years).

But even on the returns to date, it might be reasonable to pose some questions.    The Fund puts a lot of emphasis on expected returns, and not a lot (at least in the published material) on the risk they are running.    In some respects, that is in line with Parliament’s mandate for them to be

maximising return without undue risk to the Fund as a whole;

What, we might wonder, is “undue”?   Who decides, and under what constraints?

A common measure of risk, especially on assets that are frequently marked to market, is the variability of returns.    One tool for relating returns to risk is the so-called Sharpe ratio, which compares the incremental returns obtained through the fund manager’s investment management choices (ie the margin above a risk-free rate) with the standard deviation of those returns.  If the resulting number is very low, the incremental gains might often be prudently best treated as “noise” –  good luck, perhaps, rather than the result of a consistently superior investment strategy.  On the other hand, all else equal a high Sharpe ratio, over a reasonable period of time, provides greater reassurance that the fund manager is adding value.   When I ran the Reserve Bank’s financial markets operations, we had able staff proposing all sorts of clever active management schemes to add value to our foreign reserves operation.  Sharpe ratios were one of the tools we used to evaluate prospective and actual results.

How has the NZSF done on that metric?  Since it opened the doors, the average annualised return has been 9.9 per cent (recall that NZSE50 return of 9.8 per cent).  Treasury bills –  the Fund’s risk-free benchmark –  provided an average return of 4.3 per cent, so the average margin over the Treasury bill return was 5.6 per cent.

But the standard deviation of those annual excess returns over the full period since September 2003 is around 13.5 per cent, for a Sharpe ratio of just over 0.4 per cent (and these are all pre-tax numbers).  That is pretty low.  In other words, while the headline returns –  through a period of strong asset price growth –  may have looked impressive, the risks they have been running have been (deliberately and consciously) high.   I checked, by way of comparison, the returns on the low-risk (low return) superannuation fund I’m a member (and trustee) of: since 2003 the standard deviation of the annual returns on that fund since 2003 have been around 4.5 per cent.

Adrian Orr has now been CEO of the NZSF for almost a decade.  In that decade, annual returns (above Treasury bill) look to have averaged just over 5 per cent, but the standard deviation of those annual returns has been higher at around 17 per cent.  In other words, the Sharpe ratio for the Orr years, is even lower than that for the full period of operation.  But, as a reminder, the Fund itself reckons one needs a 20 year run of data to evaluate their investment management performance.

Based on the NZSF’s own data the monthly returns are also pretty volatile.  The standard deviation of monthly returns (over the risk-free rate) over the life of the Fund has been around 3.3 per cent.    Given that many of the Fund’s holdings are quite illiquid, one probably shouldn’t put too much weight on the monthly return numbers, but it is a reminder of just how much risk the NZSF is incurring –  not for itself, but for the taxpayers of New Zealand.  At best, they might just have been getting compensation for the risk they’ve taken, but there doesn’t seem to be anything exceptional about their performance given that level of risk.    That, in itself, isn’t intended as a criticism: why would we expect a public agency in New Zealand to be able to add much (risk-adjusted) value, whether through asset allocation, or tactical departures from their own internal benchmarks?  But it is a bit of a reality check.  And as Hamish Rutherford noted, on deals like Kiwibank, the super fund’s returns are, over time, likely to be flattered by the privileged position NZSF had going into negotiations –  there were very very few buyers acceptable to the government, and ACC and NZSF will have known that, and reflected it in the price they offered NZ Post.

My own unease about NZSF is rather more fundamental, and doesn’t reflect on any of the individuals involved in managing the funds or the organisation.   The NZSF is often loosely described as a sovereign wealth fund.  In fact, it is nothing of the sort.    Norway and Abu Dhabi have sovereign wealth funds –  accumulated from the proceeds of the sale of state-owned natural resources (oil and gas).   It is real wealth, and needs to be managed somehow.  Of course, it could all be passed on to citizens to do with as they please, but there are plausible –  not necessarily 100 per cent compelling –  reasons for managing the flow of the proceeds of the sale of a large non-renewable natural resource over time.    If so, the money is there and has to be managed somehow.

By contrast, the New Zealand Superannuation Fund arose because successive governments took more in taxation from New Zealanders than they needed to fund their operations.  At one stage at looked as though the New Zealand government would manage to build up a large financial asset position.  But, except briefly just prior to the 2008/09 recession, they didn’t even manage to do that.  Instead, we now have a quite large stock of government debt outstanding, $33 billion of which is used to run a state-sponsored and managed quite-risky hedge fund.   It is a discretionary commercial operation, and it should be evaluated on the same sorts of grounds Treasury and the government lay down for other investment projects.  And given that risk imposed on us by the government is risk (capacity) we could ourselves otherwise choose to utilise elsewhere, it should also be evaluated by looking at the sorts of returns private sector businesses require in analysing possible uses of capital.

Treasury has recently revised downwards the pre-tax discount rates it recommends government agencies use in evaluating projects.  Their default recommended rate is now 6 per cent real (or around 8 per cent nominal), but over most of the period of the life of the NZSF they were recommending a real discount rate of nearer 8 per cent.  They continue to assume an equity risk premium of 7 per cent.  Against those sorts of asssumptions, average annual nominal returns of 9.9 per cent just don’t look that attractive, especially when subject to huge variability (that 13.5 per cent annual standard deviation).    I don’t know what assumptions NZSF are making about expected absolute returns over the next decade, but it would be a bit surprising if they were forecasting/assuming returns as high as those on offer for the last 14 years.

Another way of looking at whether the NZSF is a good business for the Crown to be in, on behalf of taxpayers, is to look at the returns private sector businesses require.  I’ve linked previously to a nice article from the Reserve Bank of Australia, drawing on a survey of private sector businesses asked about what hurdle rates they used in approving/declining investment decisions.  I summarised it previously thus:

They report survey results suggesting that most firms in Australia use pre-tax nominal hurdle rates of return in a range of 10-16 per cent (the largest group fell in the range10-13 per cent, and the second largest in a 13-16 per cent band). Recall that nominal interest rates in Australia are typically a little lower than those in New Zealand, and their inflation target is a little higher than ours.   In other words, it would surprising if New Zealand firms didn’t use hurdle rates at least as high in nominal terms as those used by their Australia peers.     The RBA reports a standard finding that required rates of return were typically a little above the firms’ estimated weighted average cost of capital. The literature suggests a variety of reasons why firms might adopt that approach, including as a buffer against potential biases in the estimated benefits used in evaluating projects.

And here is one of their charts


Bottom line: private citizens shouldn’t want governments getting into businesses –  especially not relatively risky businesses –  where the returns are less than 10 per cent.

There are other reasons to be concerned about the economics of the NZSF:

  • putting money into NZSF required tax rates to be higher than otherwise (as would the shared commitment to resume contributions at some point).  Higher tax rates discourage some economic activity that would otherwise occur here, and New Zealand tax rates are not now unusually low by international standards (our company tax rate is quite high),
  • the scheme involves all New Zealanders in direct financial exposures to companies/industries they may disapprove of. NZSF attempts to get round that with their ‘socially responsible’ investment policy, but your view of “socially responsible” companies/activities may well differ from that of your neighbour.  Personally, I’d be quite happy to have money invested in whale fishing companies.  Many others might not.    Making those choices simply isn’t a natural or necessary business of government.
  • large pools of government financial assets encourage the misuse of those funds in the event that the country/government comes under financial stress at some point in the future.  Those sorts of tail risks aren’t captured in the monthly or annual standard deviation numbers.
  • NZSF, being a quite high risk fund, tends to perform well in periods when the government’s finances are not under stress, and to perform badly (very badly in 2008/09) when government finances come under most stress. Because the assets are quite widely held, it provides some protection against some sorts of shocks, but in any severe global economic and asset market downturn –  the sort of event New Zealand is never immune to – the NZSF investment strategy simply ensures that when problems hit they are compounded by investment losses.  As the government is already, in effect, an equity holder in all New Zealand business (through the tax system), it isn’t obvious quite why it should be attractive for New Zealanders to have the government further compound their exposures.  To take those risks might be reasonable for the prospect of exceptional returns, but the NZSF strategies look to do little more than cover a bare minimum cost of capital –  while aggravating our problems when things turn bad.

The NZSF may have been a sensible practical political option back at the start of the 2000s.  Governments were running large surpluses, positive net financial assets were in prospect, and the retirement of the babyboomers was still a decade away.   It makes little sense now, and if anything is a distraction from the necessary discussion about adjusting the NZS eligibility age in line with the longer-term trend improvements in life expectancy.  Rather than debate how to remunerate the CEO, or whether Board members should be replaced, we’d be better to look seriously at winding up the Fund now,  reducing the risks taxpayers ar exposed to and using the proceeds to repay government debt.




Labour on New Zealand Superannuation

Sometimes I wonder where Andrew Little gets his advice/ideas.

Yesterday, the Dominion-Post ran an article by Vernon Small reporting an interview with the Labour leader and his finance spokesperson Grant Robertson.   In it

Little reaffirmed his opposition to raising the retirement age – a policy he scrapped as leader – but he wants to resume payments to the “Cullen” fund that pre-funds some of the cost of the universal pension.

“Do we need to resume contributions to the Cullen Fund? Too darn right we do, (because) $14.5 billion of contributions not made in the last eight years would have been worth $20b to the fund.”

Other changes to superannuation were not being contemplated, although Little did not rule out other options such as changes to the current indexing, which is linked wage rates.

“Those are things you can have a look at. They are not big money-savers necessarily – over time they might be – but (I am) not certainly averse to looking at those sort of things.”

But New Zealand could be proud of its low level of elder poverty. “So why would you want to change that?”

I agree that the low level of poverty among the elderly is something New Zealand can be proud of.  So why would Labour want to put it in jeopardy?   Because that is exactly what changing the indexing basis would mean over time.   By contrast, raising the age of eligibility gradually –  the policy Labour previously campaigned on but has now abandoned – would be one of the best ways of securing the admirable record of keeping from poverty those unable to work because of advanced age.

At present, NZS payments are indexed to changes in average nominal wages.  That means that, over time, those on NZS share in the overall gains that wage earners achieve.  When productivity growth is low, neither wages nor NZS tend to rise very much in real terms, and when productivity growth is strong the elderly get to share in the gains.  It is easy enough to run an economist’s argument for an alternative approach:  index to the CPI instead (as some favour) and NZS is kept at a constant real level, regardless of what happens in the real economy.  If the current real level of NZS is enough to keep poverty at bay, that same level should keep poverty at bay in future –  at least if “poverty” is defined the same way.

Changing the indexing basis makes a huge difference over time.    In their recent Long-Term Fiscal Statement, looking ahead of 40 years, Treasury (perhaps optimistically) assumed annual labour productivity growth of 1.5 per cent per annum.  Only a couple of days ago, they tweeted the chart from the report highlighting just how much would be saved by indexing to the CPI instead of to wages.  But the flip side of moving to CPI indexing is that NZS payments received by individuals in the future would be much lower than they would be under the current rules.  In fact, on the Treasury productivity assumptions, NZS weekly payments 40 years hence would be only around 55 per cent of what they would be on the current, well-established, formula.   Adopting such a rule would almost certainly see a big increase in the number of elderly people measured as living in poverty –  and since community expectations, and regulatory minimum standards in a whole range of areas, tend to rise with economic growth it is almost certain that there would be an increase in real hardship.  Imagine if real NZS weekly payments had been held constant for the last 50 years.

There is nothing inherently right about the current real (absolute or relative) level of NZS.  It is the outcome of a series of political (com)promises.  Sure some money could be saved by moving to CPI indexing for a while, but CPI indexing would almost certainly be untenable and unsustainable in the long run, reopening intense debates every few years as to just what level of income superannuitants should receive.  Avoiding the bitter fights around NZS that characterised New Zealand politics from the mid 80s to the late 90s seems highly desirable.

What I found really puzzling about Little’s reported remarks is that changes in the indexing arrangements would affect everyone who receives NZS –  and would potentially adversely affect them for the rest of their lives.  By contrast, changing the eligibility age doesn’t affect those (a large number of voters) now receiving NZS at all.   And changing the eligibility age slowly, as New Zealand can still afford to do, is a very slight dislocation for most people.   Increase the age of eligibility by, say, two months a year until the age gets to, say, 68, and then index any future increases to future increases in life expectancy.  On that rule, someone who was 60 when the policy change took affect might have to work until almost 66, instead of until 65, to receive NZS.  From their perspective, of course it is a loss and unwelcome, but it isn’t a huge dislocation.  And it is a much slower pace of adjustment than we adopted in the 1990s and early 2000s, when the age of eligibility was raised from 60 to 65 at a rate of six months a year –  and governments managed to get re-elected nonetheless.  I don’t imagine there are many 50 year olds now who expect to collect NZS at 65.

Yes, there are some people who are physically unable to work by the time they are 65.  There always have been, and no doubt always will be.  We have working age people now who are physically unable to work.    And any compassionate society needs to make provision for those people.  But that needn’t mean a universal entitlement at age 65 indefinitely.

The other overdue change to the NZS system is to alter the rules of eligibility.  A residency requirement of only 10 years to claim a full NZS payment seems generous to the point of irresponsibility, prioritising those with a weaker natural claim on our support, over those with a greater claim.  That is especially  so as I pointed out again recently the rules mean that for many people (especially New Zealanders in Australia) they don’t need to have lived in New Zealand –  or paid New Zealand taxes – at all.    The Retirement Commissioner proposes a 25 year residency requirement.  One other possibility might be phased residency tests: perhaps after 10 years, a person might be eligible for 20 per cent of the standard NZS payment, and after 30 years might be eligible for 100 per cent.   But that residency test should involve actual physical residence in New Zealand.

I’ve long been meaning to write a sceptical post about the New Zealand Superannuation Fund.  It was a worthy wheeze in the days when Michael Cullen set it up –  discouraging his colleagues from spending all of the large surpluses –  but it has no natural place.  There is no good moral or economic ground for keeping a universal pension at 65, even as life expectancy continues to increase,  the ageing of the population is a permanent (welcome) feature not a temporary blip, and we don’t have large surpluses any more –  and haven’t had surpluses at all for the last decade.  Labour is quoted citing the investment gains that could have been had if only contributions had been continued for the last eight years –  but (a) the scale of those gains was inherently unknowable in advance, (b) if, as many believe, global asset markets are overvalued the gains may not even be permanent (the NZSF portfolio is structured in such a way that mean that returns will be highly volatile) and (c) the flip side to putting more into the NZSF would have been even larger increases in government gross debt than we have already incurred in the last few years.  Paying public servants to take big leveraged investment risks doesn’t seem a natural role for government (although I know some of my readers/commenters disagree).

I wonder what Labour’s private attitude is?  After all, Labour governments elsewhere in the world –  notably Australia –  have put in place policies to raise the eligibility age for the state pension.  Perhaps they really hope that in next year’s Budget Bill English and Steven Joyce will take the brave but responsible step of raising the eligibility age slowly.  If they did, it is hard to envisage responsible members of the Labour Party’s leadership opposing such a stance with any conviction.