The question is, where do we get reliable ratings of the "safety" of investment products without the conflict of interest and the political biases of rating companies? It seems very difficult to impossible.
An even more out-of-the-box way to approach the problem is to ask why funds with such investment grade requirements are so important in the first place. In part it is because the rich park their money there, and public discourse is overwhelmingly determined by what the rich (edit: make it the top quintile in terms of income or wealth, perhaps) care about.
The other part is that retirement is largely organized privately via funds. I am increasingly of the opinion that that is a horrible idea.
Note that it is still a somewhat nuanced position. Of course, everybody should have the right to invest their savings into whatever they like. However, the normative default ought to be that a comfortable retirement can come out of a direct distribution system financed by taxes.
In the end, the real resources consumed by retirees come from the currently working population anyway. On that level, it does not matter how the necessary funds flow to the retirees.
However, there is a big difference in stability between an intransparent system of privately run funds based on volatile financial markets vs. a stable and transparent system of direct, tax-funded distribution.
"However, the normative default ought to be that a comfortable retirement can come out of a direct distribution system financed by taxes."
There's two problems with this idea.
First, you can only get returns for this direct distribution if wages increase or population increases. If I expect my retirement savings to grow by X% in order to finance my retirement and everyone is always paying the same percentage of their wages into the retirement account my retirement is only feasible if there are more workers that pay the same fixed percent or if the wages of the workers increase. Neither are a guarantee.
Second, if my savings (or capital) are not being allocated in the market to efficient uses (through picking stocks or funds that I think will grow) then the market loses some of its predictive power. This process is partially responsible for what enables good companies to grow and bad companies to fail. In effect, we trust the managers at the big mutual funds to allocate our capital to the good companies (and sovereign debt) and away from the bad companies (and bad sovereign debt).
The second point just goes full circle as to why Mutual Funds are required to hold investment grade products rated by the big Credit Rating Agencies.
One related point as to why the incentives of the big credit ratings agencies are the way they are. Clearly, if the investor, and not the issuer, was the one paying the rating agency then the rating agency would have an incentive to give the best possible ratings. Its a matter of only releasing your ratings information to investors that have paid for it. This is currently impossible because there are millions of investors and only a handful of issuers. How are you suppose to stop investors that already know the rating from giving it to other investors who have not paid.
Perhaps one possible solution is to have the investor be able select a ratings agency to use along with a fund when allocating savings. In this scenario you know that a percentage of your savings are going to be used to pay a ratings agency for their information, but the investor got a chance to chose who that ratings agency is possibly decreasing the revenue of the bad agencies and increasing revenue of the trusted agencies.
In my opinion the solution is almost always more consumer choice.
It is doubtful that your second point really stands against what I wrote. After all, retirement funds add at least one layer of indirection between the person who ultimately owns something (in this case, the person saving for retirement) and the economic decisions being made.
That is, retirement funds dilute responsibility.
If you wanted to analyse this whole issue seriously, you'd have to consider two separate effects: (a) private retirement funds as the normative default creates a glut of capital and (b) private retirement funds allocate their money with rather little personal involvement and responsibility. [1]
As to the first point, things are more clear-cut. Yes, in a direct distribution system your pension depends on the future state of the economy. But so does your pension if you have retirement savings! After all, where does the growth of X% that you speak of come from?
Ultimately, no matter what the system, your pension has to come from somewhere. The fact that this somewhere is obscured by a retirement funds system is not a point in its favour - quite the opposite, actually. Transparent systems are always preferable.
[1] Yes, fund managers often are paid somewhat in relation to the success of the fund. Two problems with this: This incentive tends to focus on the short term, which is opposed to the interests of the future pensioners, and fund managers have more of an incentive to increase their volume rather than increase the quality with which they manage that volume (just like real estate brokers, with a nod to Freakonomics).
The question is, where do we get reliable ratings of the "safety" of investment products without the conflict of interest and the political biases of rating companies? It seems very difficult to impossible.
An even more out-of-the-box way to approach the problem is to ask why funds with such investment grade requirements are so important in the first place. In part it is because the rich park their money there, and public discourse is overwhelmingly determined by what the rich (edit: make it the top quintile in terms of income or wealth, perhaps) care about.
The other part is that retirement is largely organized privately via funds. I am increasingly of the opinion that that is a horrible idea.
Note that it is still a somewhat nuanced position. Of course, everybody should have the right to invest their savings into whatever they like. However, the normative default ought to be that a comfortable retirement can come out of a direct distribution system financed by taxes.
In the end, the real resources consumed by retirees come from the currently working population anyway. On that level, it does not matter how the necessary funds flow to the retirees.
However, there is a big difference in stability between an intransparent system of privately run funds based on volatile financial markets vs. a stable and transparent system of direct, tax-funded distribution.