The Frail Bonds of Liberalism: Pensions, Schools, and the Unraveling of Fiscal Mutualism in Postwar New York

Abstract

Between 1940 and 1965, state-level officials changed the relationship between two pillars of the postwar social contract: secure retirement and modern public schools. In the early twentieth century, state pension managers, following an investment regime we call “fiscal mutualism,” funneled the savings of government workers into government securities. Through direct participation in municipal bond markets, pension officials lowered the borrowing costs for local governments. Yet by the 1960s, pensions had completely abandoned this investment regime. We document this transformation through a close examination of New York State’s pension fund. Throughout the 1950s, the comptrollers who managed the New York State Employee Retirement System (NYSERS), the nation’s largest state pension, underwrote the boom in suburban school construction by purchasing the municipal bonds of local school districts. However, in response to changes in national political economy, along with shifts in the ideology guiding pension stewardship, New York Comptroller Arthur Levitt Sr. sought to deregulate the pension’s investment powers. Following the regulatory changes, Levitt disinvested from municipal bond holdings in favor of higher-yielding corporate securities. Pension deregulation secured higher returns for state retirees, but it also forced local school districts to enter bond markets without the backstop of fiscal mutualism. As school budgets, and the property taxes supporting them, soared to repay the interest costs, tax revolts became a permanent response to the fiscal volatility. These transformations, we argue, stemmed from postwar liberalism’s dependence on financial markets to deliver retirement security, public education, and other social benefits. This public dependence on private capital foreclosed more ambitious policy alternatives and ceded power to private actors—particularly investment bankers and bond investors—who prioritized their own profits over social welfare provision.