, Editorial Director
According to the Federal Reserve Board's flow-of-funds statistics, the assets held by private defined contribution plans now exceed those held by private defined benefit plans. Since 1988, defined contribution assets have grown at a 12.6% compound annual rate. Defined benefit assets, in the same period grew at a 9.1% rate. That is, defined contribution assets have grown 38% faster.
By all appearances, this trend will continue. Defined contribution plans will continue to dominate the pension scene. No revival of defined benefit plans is in sight.
No problem, right? We're just swapping an old, less-flexible form of pension provision for a more flexible one that employees (and employers) seem to prefer.
Wrong. There will be hidden costs to the economy as a whole from the switch to defined contribution plans -- arising from differences in the way they are invested. We've probably killed the defined benefit goose that helped lay the golden eggs we are now harvesting in our economy.
Since 1980, defined benefit pension funds have invested in a wide range of investment vehicles, most of which helped the economy in numerous, non-obvious ways.
Defined benefit funds and their money managers have, through the capital markets, allocated capital to the areas expected to generate the highest expected returns. The competing investment ideas of the money managers have helped make the capital markets more efficient, and through them, improved the efficiency of the economy.
For example, the rise of Silicon Valley and the technological revolution it has generated coincided almost exactly with the first serious forays by defined benefit funds into venture capital investing beginning in the early 1980s.
Pension funds did not spark the Silicon Valley revolution, but they provided a significant amount of financing to the venture capital industry at a critical time. They at least provided the marginal dollars that made the difference in many cases.
Likewise, pension fund participation in leveraged buyouts helped improve the performance of many corporations. Though not every significant LBO worked, the existence of buyout groups, amply financed by major pension funds, prodded corporate CEOs all over the country to manage their company's assets more aggressively and efficiently. If they didn't, they risked being takeover targets. Would the corporate restructuring that has occurred over the past decade have taken place anywhere near as rapidly or completely without the LBO threat? Unlikely.
And it further was stimulated by the corporate governance movement, again driven by defined benefit pension funds.
As the growth of defined benefit plan assets continues to slow, what will take up the slack in these areas? Few, if any, defined contribution plan sponsors are likely to offer venture capital or LBO funds as options.
There will still be some flow into venture capital and LBO funds trickling down from the surviving defined benefit funds and individual investors seeking higher returns. But it will be nothing like the flows of the past 15 years, and financing costs will be higher.
If America's economic vitality begins to wane in the next decade you'll know who deserves some of the blame -- those in Congress who fatally weakened the defined benefit system.
