The Democrat who worked with Bush
One can tell at first meeting that Robert Pozen is a busy man and a multi-tasker. Throughout our interview he not only discusses the future of the US and European pensions systems and forcibly rebuts suggestions that MFS Investment Management, the company of which he is executive chairman, had
engaged in fraud, but constantly consults and sends texts on his blackberry and reads through and adds to a speech he is going to deliver later that day.
And indeed during his career he has undertaken a number of tasks. These have included being Massachusetts' secretary of economic affairs and helping close the state's yawning budget deficit, as well as being vice-chairman of Fidelity Investments, during which time he was credited with instituting tighter controls at the Boston-based group.
That role came in useful when in February 2004 he moved to his current day job at MFS in the wake of a fund-trading scandal.
Within weeks of his appointment MFS settled civil fraud charges with federal and state regulators that alleged it had allowed rapid trading in nearly a dozen of its funds by agreeing to pay $225m in penalties and restitution and to cut its management fees by $125m over five years. It also agreed to pay an additional $50m to settle charges that it had not properly disclosed payments to brokers for promoting its funds.
The suggestion of fraud clearly still rankles. "That is not correct," he says. "The company was found to have allowed what the SEC viewed as excessive market timing. There has never been any proof that there was intentional fraud and in fact it is unclear whether or not investors were damaged by that."
But the payments? "In neither case did we admit to any fraud," he insists. "But we quickly resolved all the regulatory issues and put them to bed. It may be the case in retrospect that in order to get them resolved very quickly maybe we did not have to settle certain issues but we did. These were technical issues and that is why it is upsetting to me when someone says fraud. There wasn't fraud here. If there was fraud I would not have come to the firm."
But he is perhaps best known for having served on President Bush's commission to strengthen social security, during which he developed two models for closing the system's long-term deficit.
He later proposed the restoration of the social security system's solvency through progressive indexing, a method that has since been publicly endorsed by Bush. As a Democrat, how did Pozen find working on Bush's social security commission?
"The commission did a lot of good work because for the first time we were able to develop models to show the financial implications of various reform proposals. We went from the situation where people had ideas with very rough and ready estimates to a set of models by which we could estimate precisely what was going to happen to the overall solvency of social security and what was its impact on low earners, middle earners and high earners. Then we developed two different proposals: a total move from wage indexing to price indexing and a longevity model moving retirement age and the actuarial value of it.
"Progressive indexing basically says we keep the low-rate worker on wage indexing and take the high-rate worker earning above $90,000 and we price index their benefits, with the middle getting a blend. And that reduces the 75-year social security deficit to $2.8trn from $4trn. And even in Washington that's a lot of money."
Was Bush impressed? "In January 2005 right after his election, all he talked about on the social security front was privatisation, privatisation, privatisation. That in my view was a two-fold tactical error. He knew that taking a portion of the social security tax and putting it into a private account does not touch social security solvency and you have got to address solvency before you can get to all these personal accounts. I have said over and over that you've got to eat your spinach before you can get desert. Second, in talking about privatisation he created a political problem for himself by scaring a lot of people, even people already in social security who quite frankly would not have been touched at all by his proposal.
"But in March 2005, after two months of perhaps not getting as
good a reception as he wanted, he out of the blue endorsed progressive indexing. Why? Not because he thought Bob Pozen was a great guy but because he understood he needed to have a solvency approach and one that was a fair, that took into account that there was a DC system in which middle and higher wage earners were getting lots of tax benefits while lower wage earners were not. So I commend him for at least getting to solvency."
In an article published by the Wall Street Journal in January entitled ‘The bi-partisan approach to social security' Pozen suggested that Republicans get off privatisation and instead think about a personal account and that Democrats ought to embrace progressive indexing and not push for a big increase in the payroll tax. Since then treasury secretary and former chairman and CEO at Goldman Sachs Henry Paulson has adopted that overall approach.
"He has been discussing it extensively with congressmen and senators from both parties," says Pozen. "I don't know whether he can actually pull off a deal but I think he is genuinely trying."
But is it all too late? Pozen thinks there's a chance. "We basically have between now and November to get legislation through," he says. "After November, no legislation. So the answer is there probably is time if people want to do it. A lot of work has already been put into this and we have drafted bills with progressive indexing. We know how to solve the problem of social security in the US, the only question is how much progressive indexing, how much longevity indexing, how are we going to use these different tools and how much are we going to reduce the deficit. It's a question of the mix."
What about the situation in Europe. "I think you have two different Europes, the Europe of the UK and countries like the Netherlands which have a pretty high percentage of funded pensions, have moved to deal with their DB issues and have started DC issues, and those where the first pillar replacement rate is at 70% and 80%, which are going to find that unsustainable and where that is going to have to come down to 40-50%.
"So maybe you have a range between 35% and 65% that the first pillar supplies. The point of the second pillar is not that it supplies a 100% replacement but that it supplies another 20%, 30% or 40%. So let's just assume that the first pillar in the Netherlands is at 40%, you should be able get people 30% of their pre-retirement income through DC. If people want more than 70% replacement in retirement then the answer is twofold: they can get more personal savings in the third pillar and some are going to have to cut back on their way of life, their expenditure."
"In the UK, the new insurer for pensions, the PFF, is trying to avoid the mistakes that we made in the US, where the PBGC had no risk-rated premiums and very high minimums. In the private sector the UK, like the US, has moved towards a DC system and the social security government pension has moved away from wage indexing to price indexing, which has made the scheme more affordable. So if you put those all together, from a pensions perspective, the UK is in relatively good shape.
"In the UK, again as in the US, there is very little chance of having a mandatory DC second pillar and in my view having-opt out is the next best thing. At one point the UK was in an opt-out situation and then it moved to an opt-in situation. In the US we are just doing the opposite, we are now moving towards opt-out rather than opt-in because we found that in DC plans there is a huge change in terms of participation. If you have to write down all the information and fill out an application, the participation rate in DC plans in the US is about 60% but if you are presumptively enrolled and have to opt out, the participation rate goes up to 90%.
"In the US we don't even require that an employer offer a retirement plan. I am part of a group that has made what we call a connectivity proposal where an employer should be required to choose a qualified financial institution to offer their employees a plan and, although not having to contribute, should go into payroll deduction and at least allow pre-tax payments. Opt outs were adopted in legislation last year and we are now at the regulatory rules setting stage. Connectivity has not been adopted legislatively but it was endorsed by the US Chamber of Commerce commission report on capital markets in the twenty first century, issued in March.
"If you compare the UK with the US I would say it is in a reasonable situation. It is going to learn from our mistakes in the DB side, hopefully will pick up what we are doing on the DC side and presumably will move towards an opt-out type of situation. But if you look at continental Europe, the Netherlands excluded, the demographics are bad and in many cases the traditional DB system is not properly funded. In my view this combination in places like Germany, France and Italy is a very serious problem. They have tried to introduce DC with the Riester accounts in Germany and various other plans in France but with limited success so far; the amount of money going into to those schemes is quite modest.
"The Netherlands is a different matter. Its DB system has been pretty robust, they have done a lot of funding, they have pretty diversified accounts and they have very creatively shifted to what might be viewed as a hybrid between a DB and a DC. These are new systems that basically allow you to continue to have benefits based on years of work or last three years of salary, for example, but where the employer makes contributions but is not going to be held liable if there is a long-term deficit."