SWFs: The New Geopolitical Power Tools, Says MIT Scholar

(September 24, 2012) – The $5 trillion held in sovereign wealth funds (SWFs) worldwide is more than just resource riches and future social services, according to the Massachusetts Institute of Technology’s Shannon Murphy.

More and more, it’s also political power.

Sovereign wealth funds “provide the ‘carrot’ of sizable, patient capital, and wield a ‘stick’ via their ability to serve as investors of last resort,” Murphy writes. “This has resulted in sovereign wealth funds becoming, in some ways, a proxy for power/influence at home and abroad. The ability of non-OECD [Organisation for Economic Co-operation and Development] states to leverage SWF resources to earn excess financial return and accrue global influence, facilitate domestic economic development or meet the long term needs of citizens is reorienting relationships.”

The paper, titled “Leviathan’s Double Bottom Line: Sovereign Wealth Funds as Tools of Strategic Statecraft” and published earlier this month, is Murphy’s thesis for MIT’s Sloan School of Management.

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Using the China Investment Corporation (CIC) as a case study, she argues that nations tend to invest sovereign wealth in the resources their citizens need, not the assets with the most promising returns. The CIC has concentrated much of its $482.2 billion in Africa, Canada, and Russia, securing vast quantities of oil, natural gas, copper, and iron ore, among other real assets, from these the resource-rich regions. These investments are also diplomatic olive branches, Murphy contends. In May 2012, China and Russia signed a strategic trade deal—a deal that her research indicates was largely a product of the CIC’s investments in Russia, including $1 billion allocated to Russia’s own sovereign wealth fund.

These hybrid political-financial arrangements, Murphy writes, will increasingly be necessary just to keep up with global powers.

“Sovereign capital’s arrival as a global financial force may mean that countries who do not seek policy benefits alongside financial returns could find themselves left behind. The question is increasingly becoming why not pursue strategic goals along with financial ones?”

Read Shannon Murphy’s entire paper here.

The Baltimore Fire and Police Retirement System may be once again on the hook for tens of millions in annual payouts that had been cut in a 2010 reform package.

(September 24, 2012) – A federal judge has overturned a key provision of Baltimore’s 2010 pension reform, calling changes to the cost-of-living adjustment “unconstitutional” and not “reasonable and necessary to serve an important public purpose.”

“There was an important public purpose to be served by the restructuring of the Plan so as to restore it to actuarial soundness and sustainability,” Judge Marvin Garbis wrote in his ruling. “Hence, the City’s impairment of Plaintiffs contract rights, including their rights to the Variable Benefit feature, could be Constitutionally valid if ‘reasonable and necessary.’ However, the City did not have total freedom to disregard its contractual obligations altogether.”

The city’s police and fire unions challenged Mayor Stephanie Rawlings-Blake’s 2010 reforms in court, in the press, and on picket lines in front of City Hall.

To close the Baltimore Fire and Police Retirement System’s $121 million deficit, the city council had passed legislation increasing the years of service required of new hires for pension eligibility, fixing the annual cost-of-living adjustments at 1% and 2% for current and future retirees, hiking employees contributions from 6% of pay to 10%, and calculating benefits based on members’ average salary over the last three years, not 18 months. The mayor’s ordinance also stipulated that the City of Baltimore boost its contribution by about $20 million year-on-year.

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Mercer consultants estimated that this package of reforms would reduce unfunded liabilities from $1.28 billion to $1.16 billion, despite adjusting the assumed rate of return from 8.25% down to 8%. Post-overhaul, Mercer calculated, Baltimore’s police and fire pension fund would be 88% funded, up from 84.8%.

In his ruling, Garbis agreed with a reworking of the Baltimore pension system in theory, but concluded that replacing the variable cost-of-living adjustment with a fixed annual increase unfairly impacted young employees.

“While the City was justified in acting to stabilize the actuarial footing of the Plan, the Ordinance scheme was not ‘necessary,’ in the sense that the impairment far more drastically impaired the contractual rights of some Plan members than others while a perfectly evident, more moderate and even-handed course would have served its purposes equally well,” he wrote.

George Nilson, the administration’s solicitor, told the Baltimore Sun that he was “almost certain” the city would appeal to a higher court.