One of the most surprising suggestions in the economic plan that the Trump campaign rolled out last week was that the United States should start a sovereign wealth fund. Members of President Biden’s team had already been pushing the same idea; they see it as a way for the government to invest in national security projects. We normally associate countries like Norway or Singapore with sovereign wealth funds—places that run surpluses, hold massive reserves, or generate lots of revenue from natural resources. But America already has a sovereign wealth fund—many, in fact, and they’re managing assets worth more than $5 trillion. That’s how you could describe public pension funds, which take taxpayer dollars and invest them in private and publicly sold assets—often in politically favored projects—to pay out benefits. These funds are running short of money for the same reasons that a U.S. sovereign wealth fund would.
The main concern with starting a new sovereign wealth fund is that America is a net debtor. Starting a fund would require redirecting existing government revenue (Trump surrogate Doug Burgum says he envisions using revenue from oil and fracking activities), and that means running up yet more debt. This is essentially taking a leveraged bet that whatever the fund invests in will more than pay off the obligations—already a risky strategy with even the most strategic investment objectives. Mix in the inevitable inducements to steer the money toward politically favored projects, and the odds of things working out are less than even.
In that one sense, public sector pensions are different than sovereign wealth funds, as they are meant to be fully funded rather than relying on debt. Participants and taxpayers set aside money to be invested until benefits must be paid out. But despite this structure, most state public pensions are underfunded. Even more remarkably, their funding status has worsened over the last 20 years, despite the stock market enjoying one of its best runs ever. Even a bull market, it turns out, couldn’t match the funds’ overly optimistic return assumptions. Public pension funds have every incentive to project unrealistic returns: higher predicted returns make the funding situation look better than it is, which, in turn, means that taxpayers aren’t on the hook to make up for the shortfalls, and present-day leaders can leave the problem to future politicians. Projecting higher returns also encourages the funds to invest in riskier and harder-to-value alternatives like private equity, many of which are looking like busts.
Another issue with public pensions—this one especially relevant for a potential sovereign wealth fund—is the temptation to direct the money to local and publicly favored projects that underperform the market, as New York City comptroller Brad Lander has done. The Biden administration is already envisioning investments that would meet political and national security goals.
This is more than just a cautionary tale about the pitfalls of sovereign wealth funds: the U.S. is already exposed to underfunded state and local pensions. Though the federal government technically has no obligation to bail them out, it probably will. After all, the Biden administration bailed out the Central States Pension Fund, a private-sector, multiemployer pension, with no haircuts on benefits. In fact, the terms prohibit any benefit cuts in the future, too. This bailout has set the expectation that the feds will guarantee private-sector pensions against benefit cuts, no matter how underfunded or poorly managed they are. It’s therefore hard to imagine that the federal government would allow benefit cuts to happen in the public sector, especially with pensions for teachers or other public servants. In effect, Washington has guaranteed public pension investments, and thus has a financial interest in them.
The U.S. government doesn’t need any extra opportunities to make bets with taxpayer dollars. American tax revenue, through the $5 trillion sovereign funds run by states and municipalities, is already heavily exposed to the vagaries of the market and our politics.
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