The trustees of New York City’s public employee pension funds, who hold $12 billion in assets, are currently pondering several plans that could provide $100 million or more in financing for housing rehabilitation and small business development in the five boroughs. No moves have yet been made, but the discussions so far have pointed up the opportunities -and the obstacles -that confront pension fund managers in attempting , to meet larger social objectives and still safeguard their funds.
Today, the five major retirement systems administered by the City of New York jointly comprise the third largest pension system in the nation. These funds have traditionally been conservatively invested in long-term corporate bonds and in the stock of major national corporations. Since 1975 the funds have, under political pressure, played a major role in averting city bankruptcy through their purchase of city securities.
But, as the threat of municipal bankruptcy has receded, and as the value of the City’s pension assets has increased, there has been a growing interest on the part of local unions, city officials and public interest groups in exploring the feasibility of harnessing some of this vast wealth to revitalize local neighborhoods.
The proposais now under consideration would provide capital at market rates of interest for home mortgages and loans for small business expansion. All of the proposals would employ certain insurance mechanisms, either public or private, to reduce the exposure of the pension funds to the risk of loan defaults. In certain cases, federal subsidies would be used to write down interest costs to borrowers.
The recent flurry of activity in New York is a reflection of the growing national interest in pension funds. With $600 billion in assets nationwide, the country’s pension funds have simply grown too big to ignore. In a single generation, pension funds have become the largest single source of investment capital in the U.S. economy. Pension funds currently own more than 25% of all common stock traded on the New York and American Stock Exchanges and hold 400/0 of all corporate bonds.
Even the investment managers who control these funds have been slow to fully recognize the economic power that has been thrust upon them. At the center of the current debate is a larger issue, one which promises to be the center of American politics in the 1980s: How much public control should be exercised over the allocation of capital resources in the U.S. economy?
Who Would Benefit?
The New York City pension issue has brought together local neighborhood groups, Wall Street brokers, pension trustees and union officials in a wide-ranging discussion on the finer points of large capital investment. But underlying these discussions are larger issues: Who would benefit from local pension investments? Who should administer such a lending program? And what risk-return criteria should local investments be measured against?
Several recent developments have served to bring the pension issue to public attention. Last October, City Comptroller Harrison Goldin issued a report which re-commended that the City’s pension trustees approve a plan to purchase up to $250 million in Government National Mortgage Association (GNMA) securities as a means of stimulating the city’s housing market. These so-called “Ginnie Mae” mortgage-backed securities would be assembled from FHA-and VA-insured mortgages on one-to-four family homes in the five boroughs. These mortgages would be originated by local banks, which would then package and sell them to the city’s pension funds in the form of securities. The securities would pay a market rate of return and carry the guarantee of the federal government. The Comptroller claimed that his plan -which is typical of proposals offered in other states -would increase mortgage activity and stimulate new construction in the five boroughs.
Last December, City Council Member Ruth Messinger, in conjunction with the Municipal Research Institute, released a major 6O-page report on the investment policies of the City’s pension funds. The report recommended that the City’s five major pension systems allocate one per cent of their assets, up to $100 million, to a Neighborhood Reinvestment Fund that would finance local housing rehabilitation and small business development.
Under Messinger’s plan, loan packages would be assembled by two local development agencies, the Com-munity Preservation Corporation and the Economic Capital Corporation, which now work directly with the city’s banking community in the areas of housing and economic development. Once insured, these loans would be purchased by the municipal pension funds for their own portfolios. All of the proposed investments would be government insured and all would pay a competitive rate of return.
A directly targeted investment program, suggested Messinger, would provide “far greater and more measurable” benefits than any mortgage-backed securities program, such as that proposed by the Comptroller. Messinger argued that the market for “Ginnie Mae” securities is so active nationwide that pension fund purchases would serve primarily to displace private investors who are already eager to buy whatever mortgages local banks are prepared to sell. The issue of “investor displacement” is one of the major concerns of advocates of alternative pension fund investments.
Messinger proposed that the city’s pension trustees work through the Community Preservation Corporation to provide financing for the moderate rehabilitation of occupied single family and multi-family dwellings. The objective would be to upgrade buildings with tenants in place -before they enter the cycle of deterioration that almost inevitably leads to abandonment. “With one-fifth of the City’s housing stock now in substantial tax arrears, the public sector must act decisively to preserve the housing we now have,” Messinger said.
The emphasis would be on providing mortgage capital to the areas the private sector has so far neglected. Under that proposal, both rental buildings and tenant cooperatives would be eligible for assistance. Since FHA insurance is generally not available for moderate rehabilitation of occupied dwellings (except where federal Section 8 subsidies are also available) Messinger proposed a combination of SONYMA (State of New York Mortgage Agency) and REMIC (NYC Rehabilitation Mortgage Insurance Corporation) insurance. The 10 per cent of each loan that would not be covered by insurance would be financed by a $10 million federal grant of CD or UDAG funds. City employees, whose funds are at stake, would directly benefit because a special effort would be made to target neighborhoods that both require rehabilitation and have a high proportion of city employees in residence.
In order to hold down the degree of federal subsidies required, the plan offers three cost-sharing measure~ that would ensure that property owners, the banking community and city government all contribute to the task of neighborhood revitalization. First, landlords would be required to reinvest at least 75 per cent of the tax shelter benefits generated by their rehabilitation projects. Second, banks which hold mortgages on distressed properties would be urged to write-down at least 50 per cent of the outstanding indebtedness on loans subject to refinancing by the pension funds. Third, the city should grant tax forgiveness of past arrearages on a building scheduled for rehabilitation in order to remove a cost burden that could otherwise make the project uneconomic.
There has been no formal response by the trustees to either the Comptroller’s or Council Member Messinger’s proposals. A special Investment Policy Subcommittee has been established with City Council President Carol Bellamy acting as chairperson. (The New York City Employees Retirement System (NYCERS) board is the largest of the five funds and is composed of the Mayor, the Council President, the Comptroller, the five Borough Presidents and three union representatives.) Also, since these reports were released, Governor Carey has called upon the state Legislature to create a Special Commission on New York State Pension Fund Investments, to explore “targeted” investmen.t proposals that contribute to the state’s economic revitalization.
The union trustees on the NYCERS board have ap-proached the issue of “targeted” local investments with a certain measure of ambivalence. The city’s unions have traditionally been more concerned with the level of benefits their members receive than with the type of investment portfolio that the systems maintain. Since pension benefits are fixed by law, the investment performance of the city’s pension system has no direct bearing on what retirees receive. At the same time, some union officials are reluctant to make any investment that would increase their exposure to New York City related securities or mortgages, since their pension systems have already made a significant social commitment to the city through purchases of city securities.
Still, local union officials such as Lillian Roberts of District Council 37 have been eager to discuss any investment plan that would directly benefit their mem’bers. Union officials have been particularly interested in a homeownership program that would provide mortgage financing to its members at below market rates.
The notion of discounting interest rates raises a fun-damental issue: should pension fund trustees relax their stringent investment criteria and accept a rate of return that is less than that which is available on competing in-vestments, if it can be demonstrated that the lower return results in significant social benefits to a community or to the members of a pension system?
The concept of choosing investments based upon their “social rate of return” is considerably controversial. The City Comptroller, as chief investment officer. would be virtually certain to reject out of hand any targeted investment program that failed to meet conventional investment criteria.
The chief advantage of the Comptroller’s program is that it would be easy to administer. Since the “Ginnie Mae” market already exists, it would. require only that the present framework be adapted to meet local r:equirements. (There is some question, however, as to whether the Comptroller will actually be able to convince local banks to cooperate with his plan. Since they already have access to the “Ginnie Mae” market, these banks have no major incentive to go to the trouble of assembling special pools of mortgages to satisfy the NYCERS system). Council Member Messinger’s plan may provide greater benefits, but implementation is more compli-cated. In addition to the NYCERS trustees, the boards of the CPC, REMIC and SONYMA must also be convinced. So far, the city’s housing officials have not stepped in to provide the leadership required to bring all parties together.
The city Comptroller’s office has expressed some general reservations about the concept of a direct mortgage lending program, such as that proposed by Messinger. Fixed-rate mortgage loans do not provide the liquidity that other investments offer. Messinger’s proposal attempts to compensate for this disadvantage by providing that each mortgage include a shared appreciation clause that would enable the pension fund to share in any profits at the time an owner sells his property. The Comptroller has also questioned the security offered by SONYMA and REMIC insurance, since both are tied at least indirectly to the credit of the State and City of New York. In actuality, the security offered by these two insurance mechanisms does not rest upon the credit of the City or the State, but rather upon a self-supporting cash reserve fund, which has been established on an acturial basis to meet projected defaults.
Basic questions have been raised by some neighborhood activists who think none of the proposals to date go far enough in providing housing investment monies for those low and moderate income residents who need it most. They suggest that even with federal financing, the interest rates demanded by the pension funds may be unaffordable by many homeowners. Some also question the wisdom of appointing the Community Preservation Corporation as lending agent for the pension fund.
The CPC has not been willing to invest in the city’s most distressed areas, and its rehabilitation work often benefits middle class residents who do not warrant special attention, according to its critics. Messinger acknowledges
Finally, several securities brokers and mortgage bankers have proposed an alternative to both the Goldin and Messinger plans. They have urged that the pension funds invest in conventional mortgage-backed securities, which are similar to “Ginnie Mae” securities in concept, but which involve conventional mortgages that carry private mortgage insurance rather than federal guarantees. Some local banks find these preferable because they avoid the paperwork and delays involved in federal insurance programs. The plan would provide mortgages on only one-to-four family homes and. while they may be excellent investments in themselves, their purchase by the pension funds would have only a marginal impact on local mortgage originations.
These conventional mortgage-backed securities would provide some relief for the severe disintermediation problems some banks now face. But, again, they could be marketed without using the pension funds. There also is no precedent for targeting them to housing in blighted neighborhoods. The investment community, whi~h assembles them, is far more comfortable with single family mortgages in the secure middle class communities of the outer boroughs.
It seems likely that the city’s pension fund trustees will approve some form of targeted local investment in the coming year. Since there is no consensus on what constitutes the optimal approach, we are likely to see a period of experimentation with various strategies. The most promising development so far is that the pension trustees have proven to be remarkably receptive to new and unconventional ideas for housing development. This is unusual for New York City, where housing policy is usually made in an atmosphere that emits much heat, but sheds little light.