Annapolis -- The Connecticut state pension system invested in mortgage programs for low-income residents. In California, pension money went to help area housing developers. And in Kansas, the public employees retirement system lent some of its money directly to area companies, a few of which ultimately went bankrupt.
In Maryland, the first and only nibble at what is known as "economically targeted investing," or ETI, came in November. That was when the Maryland State Retirement and Pension Systems decided to invest $15 million in the state-created Maryland Venture Capital Trust, a 2-year-old fund whose purpose is to invest indirectly in start-up companies in the state. The system has $14.1 billion in assets.
Economically targeted investing takes a public pension system one step beyond its traditional mission of earning the best possible return for its members with the least possible risk. With ETI, the pension plan's secondary goal is to spur economic growth in a state or region.
As long as they are able to limit risk and retain a competitive return on investment, supporters say, economically targeted investments do no harm and can help an ailing economy.
But detractors point out that if those investments really had low risk and high rates of return, the marketplace would be funding them anyway. The pension plan should be sacrosanct, they say, one of the few governmental functions completely safe from the hand of politics.
"If these investments can go to the market, if they're prudent, then they'll get funded," says Steven Sass, a Federal Reserve Bank of Boston economist. "So ETI is either irrelevant, or it's a concession."
It's understandable why states would be tempted to look to their pension systems in times of budget crisis. Public pension systems around the country hold more than $875 billion in assets, up from about $600 billion five years ago.
There have been blatant examples of pension raiding to help balance budgets. Last summer, for instance, Illinois' governor and Legislature agreed to take $21 million from the state's five public pension funds. And in a move that still awaits a federal court ruling, California Gov. Pete Wilson seized $1.6 billion from the state pension plan last July to help bridge a $14 billion budget gap.
But supporters of ETI are careful to distinguish pension raiding from economic investing.
California's Institute for Fiduciary Education completed a study of ETIs in 1989 and reported the most common categories of investment: Two-thirds of reported ETI money was in residential housing loans; almost 9 percent went toward other real estate investments; 7.7 percent went to venture capital investments; 5 percent went for small-business loans; and the rest went to a variety of fixed-income and stock programs.
The Massachusetts plan is a classic example of ETI. State Treasurer Joseph D. Malone, when he unveiled the program in September, said its goal was "to help create jobs and encourage economic growth."
The plan envisions a total of $300 million in investments, or 5 percent of the $6 billion Massachusetts State Teachers and Employees Retirement System Trust.
Two programs have been launched. One, called the Middle Class American Dream program, provides $125 million toward mortgage loans for those who otherwise wouldn't qualify, said Dierdre Coyle, a spokeswoman for Mr. Malone.
The other program will pick out $50 million in high-quality business loans from banks that the federal regulators have taken over and will pool them for resale in the secondary market.
Ms. Coyle said the investments are safe. The mortgage program, for instance, is backed by the AAA-rated Federal National Mortgage Association. And the programs satisfy an important criterion of the retirement trust -- to fill a capital need that the market wouldn't otherwise satisfy, she said.
In setting out five investment criteria, including providing a market rate of return and minimizing local risk, the Massachusetts plan is at least a step ahead of the Kansas Public Employees Retirement System, or KPERS.
In 1986 and 1987, the now $4.4 billion KPERS embarked on what ultimately became a $200 million debacle. The plan involved buying debt notes from companies, making direct loans and pursuing venture capital opportunities in Kansas and Missouri.
The program led to what became a $68 million investment in Home Savings Association, of Kansas City, Mo., which the federal government declared insolvent in March. By last fall, about $200 million in losses were uncovered, the KPERS director resigned, and lawsuits were filed against more than 100 involved in the program.
Not all ETI programs end up the way the KPERS plan did. Those who responded to the Institute for Fiduciary Education gave a "better than neutral" rating to 46 percent of the programs and said they were "very satisfied" with 18 percent. Only 13 percent of the programs earned a less than neutral rating.
But the study was inconclusive about the success of those investments. Respondents reported one-third of the ETI programs met their financial goals. Only 4 percent failed to meet the goals, but the same percentage exceeded them. The rest either said they didn't know, or failed to answer the question.
Some observers believe the best a state can hope for from ETI programs is a below-market rate of return.
"If they can do it without giving up any income, then those projects can get funded without" the pension systems, said Mr. Sass, of the Boston Federal Reserve.
Michael Clowes, editor of Pensions and Investments, a biweekly trade publication in New York, said ETI "is on the rise, and I think it's unfortunate."
"What they're doing is borrowing from future generations," Mr. -- Clowes said. That's because for most state pension plans, if the investments don't earn enough to meet the benefit obligations, the money must come from somewhere, and that means higher taxes sometime down the line.
Further, Mr. Clowes said, a small investment like Maryland's $15 million venture capital commitment can become "the thin edge of the wedge," which politicians can use to argue for bigger investments later.
The $15 million investment, to be spread equally over three years, is a tiny drop in a $14.1 billion bucket, the amount of MSRPS assets as of Dec. 31, 1991.
Even so, the investment is ominous for some pensioners. "We're afraid this is going to be the start of something bigger," said Janet Anderson, a spokeswoman for the 28,000-member Maryland Classified Employees Association.
Herb Dyer, executive director of Maryland system, said he recognizes the employees' concerns. "Unfortunately," he said, "sometimes the pension trustees have to look beyond what the pensioners think is best for them."
He said the venture capital trust is a prudent investment. That's partly because it won't be going directly to start-ups, but rather to venture capital firms that pool capital and spread it around like a mutual fund, looking for a high overall rate of return.
For some trustees of the Maryland system, the concern over the nature of the investment is matched by the way the decision was made, and the pressure Gov. William Donald Schaefer purportedly exerted for it.
Mr. Dyer denied there was any arm-twisting by the governor or anyone else.
But Malcolm Barlow, one of the 12 MSRPS board members and a fierce opponent of the $15 million investment, said 5 of the 7 votes approving the ETI came from either Schaefer aides or appointees to the board.
Mr. Barlow said Budget Secretary Charles Benton made a rare appearance at the board meeting to push for the investment.
"Not even Richard Nixon approached the gall of William Donald Schaefer," Mr. Barlow said, warning that the governor is likely to seek more economically targeted investments. "He's tasted blood."
Although Mr. Schaefer has "no plan on the table right now" for another pension investment, "he likes the idea of the stimulus to the economy," said spokeswoman Page Boinest.
Pension funds and ETIs
(Based on a national survey on economically targeted investments. Data are for 99 pension funds that responded.)
Pension fund assets.. .. .. ..$509 billion
Assets invested in ETIs.. .. ..$7.3 billion
Number of funds with ETIs.. .. .. .. .. .41
WHERE THE ETI MONEY IS INVESTED
Residential housing loans.. .. .. $5.1 billion
Other real estate investments.. .. 0.5 billion
Venture capital.. .. .. .. .. .. ..0.3 billion
Small-business loans.. .. .. .. .. 0.2 billion
Other.. .. .. .. .. .. .. .. .. .. 1.2 billion