Arnold Kling  

Public-sector Enron

Mental Health... "Mental Health," Moral Charact...

James Hamilton writes,

When I heard about the disastrously irresponsible investments made by the Amaranth hedge fund, my first reaction was, who would be so stupid to have put up the margin requirements for such a scheme? The answer turned out to be found in my own backyard-- the San Diego County Employees Retirement Association apparently donated over a hundred million dollars to this worthy cause.

In the private sector, a company that fritters away its pension fund gets into trouble (although perhaps not enough trouble, given the moral hazard in the way we run the Pension Benefit Guaranty Corporation). In the public sector, the taxpayers bear essentially all the risk.

The agency problem is difficult enough in the private sector. In the public sector, it is worse. Ideally, you would regulate public-sector financial agents much more closely than private-sector agents, in order to compensate for the weaker incentives for self-regulation.

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COMMENTS (2 to date)
eric writes:

I think the average hedge fund Sharpe ratio is about 0.8-1.0, much higher than that for index funds (about 0.4 Sharpe) with a beta much closer to 0 (the market has a beta of 1), and that includes a generous accounting for the occasional failure that gets eliminated from databases. Look at a hedge fund like a stock, so one loses 75%, no big deal if you have 20. For a multibillion dollar pension fund, you would be foolish not to invest in a variety of hedge funds (or pay 2% and get a fund of funds). Poor retail investors are precluded from this via an overbearing regulatory structure. As the song goes, one bad apple don't spoil the whole bunch.

Bruce G Charlton writes:

AK is dead right about public sector mistakes going un-punished.

In the UK, following massive increases in public sector financing (eg. doubling of the GDP percentage devoted to the National Health service in less than 10 years - even before this the NHS was the biggest employer in Europe) there have been multi-billion dollar losses due to incompetently executed IT schemes in the NHS and elsewhere.

These epic losses to UK taxpayers have attracted little more than tut-tutting. Indeed, they are often blamed on the private sector suppliers of IT.

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