A revolution has occurred in the United States in the past 50 years. Unlike most revolutions, this one was directed and driven by those generally considered among the most conservative in the nation -- bankers, insurance executives, money managers and corporate executives. And it was powered, not by aroused passions, but by a flood of money released, inadvertently, by a decision of a federal government regulatory agency.
This revolution, and its flood of money, have helped shape the U.S. economy, the role of the federal government, the financial security of individuals and financial institutions, and capital markets worldwide.
Yet this revolution -- in the way the nation's retirement savings are invested -- has gone largely unnoticed by most of those affected by it.
When Pensions & Investments' editors sat down a year ago to start planning this issue, I decided to use P&I's 25th anniversary as an opportunity to write the book many of us felt was long overdue.
We think it appropriate to excerpt the book, tentatively titled "The Money Flood: How Pension Funds Changed the Capital Markets," here. The book is expected to be published next year.
While researching the book, I interviewed more than 60 people who played key roles in the development of the pension industry as we know it today.
Ten of those interviews -- plus one with Gary Brinson by Editorial Page Editor Barry B. Burr -- are interspersed among the book excerpts, bringing you key personalities' recollections of how they got their start.
Although P&I didn't start publishing until 1973, the history of pension fund investing is rooted in the 1948 National Labor Relations Board's Inland Steel decision. The ruling -- that Inland Steel Corp. must negotiate with its unions on pension issues and pensions "lie within the statutory scope of collective bargaining" -- acted like a dynamite charge exploded at the bottom of a dam, triggering a flood of money.
As companies began to increase the funding of their pension plans, they began to search for ways to get more out of those contributions, rejecting the dominant insurance annuities.
First to benefit were banks, often those that provided the corporations with financing. The banks initially invested the assets in bonds, later moving to balanced portfolios that included stocks and bonds.
But U.S. common stocks were only the first small steps toward the diversified portfolio of the 1990s.
A NEW ERA
Meanwhile, by the early 1970s, the market was being driven by institutional investors such as pension funds or their money managers. A new era was beginning, one that would eventually drive most bank trust departments out of the investment management business and would swing most of the active investment of equities to investment counseling firms.
These changes were driven by the need to invest the flood of money from new pension plans, but they were greatly accelerated by the work of academics who had begun to wrestle with the economic and financial implications of the capital markets, giving rise to a whole new avenue of economic research, and a whole new branch of economics called financial economics.
The revolution created the professional institutional investment management industry. It involved whole new institutions that sprang up solely to manage the assets of pension funds. And they, too, spun off new institutions. This was an industry that "money rained on," said Jan Twardowski, principal at the Frank Russell Co., Tacoma, Wash.
WHAT IS PRUDENCE?
In the past 50 years, the concept of prudence -- indeed, the concept of risk -- has changed, and with it the investment practices of the financial institutions.
Today, pension assets routinely are invested -- publicly and privately -- in the stocks and bonds of corporations in the U.S. and throughout the world.
They are invested in the bonds issued by the U.S. Treasury and governments around the world.
Through venture capital pools, pension plans have helped and are helping startup companies raise the financing needed to get off the ground.
U.S. pension assets have financed the building of office complexes, factories, department stores and warehouses throughout the nation. They have financed infrastructure development in South America, Southeast Asia and even in China.
Their activities have helped power the development of real capital markets throughout the world.
Such is the power of this flood of money that governments cannot take fiscal or monetary action without considering the reaction of those overseeing the investment of the assets. It is possible for the reaction of the managers of these assets to offset the intended impact of the government action. Some governments even consult pension fund managers before acting.
And the growth of the assets, and changes in the way these assets are being managed, will further complicate government economic policy decisions in the future.
The excerpts that follow -- organized by topic -- tell the story of this flood of money and the yet-unfinished revolution it powered.
To paraphrase Winston Churchill: We are not yet at the end, not even the beginning of the end. But it is, perhaps, the end of the beginning.