The U.S. Navy Pension Fund, 1800-1842
Recent projections indicate that expenditures on Social Security
retirement benefits will begin to exceed payroll-tax revenues and
trust-fund earnings before the year 2020, and the Old Age, Survivors,
and Disability Insurance (OASDI) trust fund will be depleted within
roughly ten years of that date. If substantial changes are not made in
the Social Security system, then expenditures are projected to exceed
revenues by more than 5 percent of the payroll covered by the Social
Security tax. Numerous analysts, commissions, business groups, and labor
organizations have studied this situation and made recommendations for
changes in the system. One proposal is for changes in the investment
strategy of the OASDI trust fund. Presently, tax receipts beyond current
outlays are placed into the trust fired, which is permitted to invest
only in special-issue U.S. Treasury "bonds," which are
essentially accounting entries in the budget of the U.S. government.
Many reformers favor some type of private investment of Social Security
funds. Proposals include (1) retaining the current structure of Social
Security benefits but investing part of the existing trust fund in
private equities and bonds, (2) establishing small individual accounts
that would be centrally managed with some or all of the funds being
invested in private securities, and (3) directing most of an
individual's Social Security taxes into private accounts that would
have a wide range of private investment opportunities.
Proponents of investing Social Security funds in private securities
point to the higher expected returns compared to current investment
practices. If the funds were invested in the equity or liabilities of
private corporations and if they earned returns similar to the average
returns over the past fifty years, then Social Security recipients could
enjoy greater retirement benefits at the same cost, or the same benefits
with a lower tax burden, or some combination of the two. Depending on
the proposal and the investment strategy, such a change in investment
practice could partially alleviate the system's long-run financing
problems.
Opponents of investing a portion of Social Security funds in
private assets highlight the greater risk associated with private
securities relative to federal debt. Those risks include greater
variation in year-to-year returns, possibilities of large capital
losses, and the risk of fraud and malfeasance in the management of the
funds specifically and in financial markets more generally. Inevitably,
with private investments some retirees may have lower pension benefits
than they would have had if all funds had been invested in government
bonds, whereas other retirees will have higher benefits.
The debate over permitting the Social Security trust fund to invest
in private securities has proceeded without reference to past U.S.
experience with the investment of public pension funds in private
securities. Indeed, our review of the literature suggests that
participants in this debate have assumed, either implicitly or
explicitly, that federal pension funds have never been invested in
private assets. But they have been. In the first half of the nineteenth
century, a substantial proportion of the assets in the U.S. Navy pension
fund were used to purchase equity in private companies.
Although the modern Social Security system dwarfs the
nineteenth-century navy pension fund in both size and scope, the issues
involved in the coverage and funding of the benefits reflect many of the
same concerns facing the Social Security system today, and the history
of the navy pension fund provides a case study of the potential problems
associated with the investment of public pension funds in private
equities. Among those problems are the government's inability to
credibly shift the risks associated with privatization to those insured
by the fund and the government's tendency to increase the benefits
as the fund grows.(1) In the case of the naval pension fund the
bankruptcy of private firms whose equity composed a substantial
proportion of the fund's portfolio ultimately led to
taxpayer-funded bailouts. Also, Congress substantially extended the
benefits in response to an existing surplus in the pension fund, an
action that ultimately resulted in its insolvency. This history has
relevance to current debates about the privatization of Social
Security.(2)
The Navy Pension Fund
During the earliest years of the republic, Congress decided to
provide disability pensions for naval personnel. Although today the term
pension is associated with retirement, the navy pension fund was
essentially a disability fund.(3) From 1790 through 1797, these pensions
were paid to naval (and army) personnel from general appropriations.
Legislation enacted in July 1797 provided that officers, marines, and
seamen injured in the line of duty were entitled to a disability
pension. In the case of officers, the pension was not to exceed half
pay, and the benefit for marines and seamen was not to exceed $5 a
month. In both cases, the benefit depended on the extent of the
disability (Seybert [1818] 1969). Additional legislation enacted in
1798, 1799, and 1800 established a separate pension fund for naval
personnel, providing a disability benefit with a maximum of half pay for
marines and seamen as well as officers. That fund was ultimately to be
financed by the sale of prizes, either ships of war or merchantmen of
belligerent states or neutral merchantmen carrying contraband.
The laws establishing the navy pension fund also prescribed the
fund's administrative structure, its management, and the
eligibility conditions for receipt of benefits.(4) The fund was placed
under the management of the secretaries of the Navy, Treasury, and War
Departments. The 1799 legislation stated that the commissioners of the
pension fund should invest all funds in "six percent or other stock
[bonds] of the United States, as a majority of them, from time to time,
shall determine to be most advantageous." However, the 1800
legislation authorized the commissioners to invest the fund's
monies "in any manner which a majority of them might deem most
advantageous" (Seybert [1818] 1969, 692). The commissioners of the
fund took advantage of their broad charge in 1809 by purchasing a large
number of shares in a local bank, the Bank of Columbia. Later they
invested in two other local banks, Union Bank and Washington Bank. Prior
to these purchases of shares, all investments of the fund had been in
U.S. bonds. Although the fund's revenue increased during the War of
1812 due to the availability of prizes, the Bank of Columbia failed in
1823-24, causing a loss of income and a temporary loss of capital at a
time of increasing obligations to pay benefits. As the pension fund
grew, the commissioners found it increasingly difficult to manage
through three federal departments. Eventually they requested that
Congress place the fund under a single department, and in 1832 the
secretary of the navy was made the fund's sole manager. At that
time Congress mandated that the Treasurer of the United States hold all
fund assets in custody, and directed the secretary of the navy to invest
all pension funds in stock of the Bank of the United States (Glasson
1918,102). The reorganization of the fund's management arose from
problems associated with the investment in the Bank of Columbia (about
which we say more later).
The 1800 act also provided that "every officer, seaman and
marine, disabled in the line of his duty, shall be entitled to receive
for life, or during his disability, a pension from the United States,
according to the nature and degree of his disability, not exceeding
one-half of his monthly pay" (American State Papers, Naval Affairs,
vol. 4, report no. 529, Jan. 17, 1834, 487).(5) In order to receive a
disability pension, a person had to complete an application indicating
the circumstances of the injury, when it occurred, the extent of the
injury, and the extent of the resulting disability. The application had
to be signed by the company surgeon and commanding officer. Injuries
could result in a partial or total disability, and the amount of the
pension depended on the extent of the disability. Pensions were
forfeited if the veteran was convicted of a felony (American State
Papers, Naval Affairs, vol. 4, report no. 524, Dec. 23, 1833, 427).
Table 1 lists the value of the interest- and dividend-earning
assets of the navy pension fund, the annual returns on its portfolio,
the number of beneficiaries, the total amount of annual benefits paid,
and the average benefit per recipient for each year between 1800 and
1842.(6) The figures show that the number of beneficiaries, the total
cost associated with their pensions, and per capita expenditures
generally increased during the life of the fund. The number of
pensioners increased from 22 in 1801, receiving annual benefits of
$1,605 ($72.95 per recipient), to 946 beneficiaries at an annual cost of
$107,129 in 1842 ($113.24 per recipient for "ordinary"
benefits and $232.60 per recipient including "extraordinary"
payments).(7)
Table 1: Estimated Annual Navy Pension Fund: Amount Invested,
Investment Returns, Number of Pensioners, and Annual Outlays of the Fund
Paid to Pensioners, 1800-1842
(a) Excludes cash holdings; therefore annual returns less outlays
do not equal the change in the value of the fund's assets.
(b) Holdings vary according to whether the assets are valued at
cost or in terms of par. It is not always clear which definition is
being used.
(c) Authors' estimates.
(d) The figures in this column were derived by equating the two
extraordinary Treasury remittances, which appear to have been passed
"straight through" a cash position to beneficiaries, with the
extraordinary claims for back benefits resulting from the act of 1837.
Source: Authors' calculations based on information in the
tables and data of Clark, Craig, and Wilson (1998) and original sources
cited therein.
(a) Excludes cash holdings; therefore annual returns less outlays
do not equal the change in the value of the fund's assets.
(b) Holdings vary according to whether the assets are valued at
cost or in terms of par. It is not always clear which definition is
being used.
(c) Authors' estimates.
(d) The figures in this column were derived by equating the two
extraordinary Treasury remittances, which appear to have been passed
"straight through" a cash position to beneficiaries, with the
extraordinary claims for back benefits resulting from the act of 1837.
Source: Authors' calculations based on information in the
tables and data of Clark, Craig, and Wilson (1998) and original sources
cited therein.
Although the long-run trends of pensioners and benefits were
upward, legislation regulating the fund tended to expand coverage,
benefits, or both when the fund expanded, regardless of its actuarial
condition.(8) For example, in 1813, benefits were extended to the widows
of navy personnel who died from wounds received in the line of duty.
Those benefits, equal to half the monthly pay of the deceased, were to
be paid for a five-year term. Payments could be renewed for additional
terms of five years each. If no surviving widow existed, these
survivors' benefits could be paid to children under sixteen years
of age. In April 1816, the commissioners were authorized to provide
benefits in excess of half pay in cases of hardship.(9) The extension of
benefits to widows and orphans, along with the growth of naval personnel
during the War of 1812, dramatically increased the payment of pensions.
In 1816, payments of $27,627 went to 327 veterans, widows, and orphans.
In 1817, benefits to widows and orphans were expanded to include those
whose husband or father had died "in consequence of disease
contracted or of casualties or injuries received" (emphasis added).
If a veteran's dependents could show that his death was somehow
connected to his previous service, then they would be eligible for
benefits. The extension sharply increased expenditures, and by 1823
pensions totaling $37,248 were being paid to 423 beneficiaries. In 1824
that provision was repealed. Persons already receiving benefits were
allowed to continue receiving payments; however, the act stipulated that
no future pensions would be awarded to widows. Despite this change, the
total number of beneficiaries continued to increase, reaching 596 in
1829, and the fund continued to grow, reaching $950,675 in the same
year.(10)
With the fund approaching $1 million and the number of pensioners
stabilizing in the early 1830s, Congress could not resist the temptation
to expand the coverage of the pension plan. In June 1834, in response to
the growth of the fund, Congress restored the provisions for
widow-and-orphan benefits that had been in effect between 1817 and 1824.
The American State Papers made the case that the fund had sufficient
resources to cover the expansion of benefits, though given the lack of
new monies resulting from prizes and the aging of the veterans of the
War of 1812, it would have been difficult to support such a claim with
plausible actuarial scenarios (American State Papers, Naval Affairs,
vol. 4, report no. 529, Jan. 17, 1834, 489). The legislation provided
for the extension of benefits to widows of officers, seamen, and marines
who had died since 1824. That extension of benefits resulted in "a
heavy charge [being] made upon the fund" (American State Papers,
Naval Affairs, vol. 4, report no. 616, Mar. 21, 1836, 863). The number
of widows granted a pension benefit under the terms of all previous acts
totaled fifty-six, but the new legislation added eighty widows to the
rolls at an annual sum of $20,031, an amount equal to nearly 40 percent
of the whole of navy pensions (American State Papers, Naval Affairs,
vol. 4, report no. 616, Mar. 21, 1836, 863).
In November 1835, the fund had assets of $1,160,262, and the income
for 1835 was $66,083. Expenses totaled $23,842 paid to 306 disabled
veterans and $30,241 paid to 136 widows and orphans. In assessing the
implications of the 18.34 legislation, the commissioners, who were also
the trustees of the fund, lamented Congress's improvident expansion
of benefits:
By March 1837, despite the recent increase of claimants and
outlays, the fund had increased to $1,115,330, and interest and
dividends exceeded $50,000. Disregarding future claims that would
ultimately arise as the War of 1812 veterans died, Congress once again
expanded benefits, approving the "Act for the More Equitable
Administration of the Navy Pension Fund" (the Jarvis Act). The
legislation required the fund to pay pensions to widows and orphans from
the dates of the veteran's death. In addition, it stipulated that
pensions granted to veterans be paid from the time they were disabled,
thereby creating substantial liabilities because of the previous
nonpayment of such benefits.
Perhaps not coincidentally, the passage of the act was simultaneous
with a 50 percent increase of naval personnel between 1836 and 1837
(U.S. Bureau of the Census 1975, 1142). That expansion was planned
during the peak of the business cycle, and Stanley Lebergott's wage
series for "able-bodied seamen" shows a peak in 1836
(Lebergott 1964, 530); so it may well have been the case that Congress
was simply increasing the total compensation of naval personnel in order
to recruit new seamen. If that was so, the panic and subsequent
recession of 1837, which began two months after the act was passed,
ultimately made it unnecessary (Thorp 1926).
In any case, the commissioners of the pension fund opposed the
Jarvis Act. The payment of back pension benefits ran as high as $6,000
to $8,000--roughly 5 to 9 percent of the total annual outlay at that
time. The annual number of pensioners increased to 847, and annual
expenditures to $103,120. "Arrears payments soon consumed nearly
$600,000. Between March 3, 1837, and October 1, 1838, about $725,000 of
the invested capital of the fund was sold, and the proceeds, with the
interest and dividend on the capital were applied to payment of pensions
and arrears" (Glasson 1918, 104). Note that the figures in columns
4 and 5 of table 1 do not include those extraordinary expenditures for
back claims; however, the inclusion of such payments (in column 6) more
than doubled the per capita outlays after 1837.
The sharp reduction of the pension fund reduced annual income while
the increased number of beneficiaries sharply increased expenditures,
resulting in the fund's further decline. Complaining about the
pressures Congress had put on the fund, the secretary of the navy
reported that the act of 1837 "has decreased [the fund] with
increasing celerity, a large portion of the pensions granted in
conformity with its provisions involving arrearage commencing many years
anterior to its passage." Primarily, this development arose from
the first section of the act, which provided that pensions to widows and
orphans "shall be paid from the date of the demise of the husband
or fathers. The only condition is, that the demise shall have happened
in the naval service." The secretary concluded that
Following the passage of the Jarvis Act, the fired declined in two
years from $1,115,330 to $253,139. Concluding that "the primary
source of the decline of the navy pension fund is the act of 1837,"
the secretary went on to note:
And that is exactly what happened.
With the pension fund facing total liquidation, Congress passed new
legislation in August 1841 appropriating $139,666 to provide for the
continued payment of pensions to current beneficiaries until the close
of the next session of Congress. Benefits would not be paid to the
widows and orphans of men who died after the passage of that act. In
1842, Congress appropriated another $84,951 and formally repealed the
act of 1837. In 1843, Congress began the practice of authorizing the
payment of two years of benefits from general tax revenues (Glasson
1918, 103).
The history of the legislation pertaining to the navy pension fund
shows that Congress, after yielding to the temptation to expand the
fund's coverage beyond its actuarial capacity to support those
covered, ultimately shifted the liability to taxpayers. The fund's
performance also reflected the other risk we mentioned in our
introduction, that associated with holding equity or the liabilities of
private firms. To that aspect of the navy pension fund we turn next.
Management of the Navy Pension Fund
The fund began investing in interest-yielding securities in 1800
and followed a fairly regular pattern of remaining fully invested with a
"buy and hold" strategy until the legislation of the 1830s
ultimately led to its liquidation.(12) The strategy reflected the flow
of funds from prizes. As noted before, the initial legislation provided
that the fund would be financed by proceeds from the sale of prizes,
which would be placed in the fund and remain there for the purpose of
paying the promised pension benefits. If the sale of prizes provided
insufficient funds to pay the promised benefits, Congress would
appropriate additional funds to make up the shortfall. That promise led
the commissioners to request that Congress reimburse the fund for losses
on its investment in the Bank of Columbia, which collapsed in 1824
(about which, more later). They made the request even though at the time
the fund had sufficient assets to make expected payments. Shortly after
Congress authorized the reimbursement of those funds in 1834, the
pension program was expanded, as we have already described. If the sale
of prizes yielded excess funds, the surplus was to remain in the fund to
provide for future benefits. As far as we can determine, no estimates of
long-term expenditures were made before the 1820s, and there was no
direct link between expected revenues from the sale of prizes and
expected expenditures on pension benefits.
Relying on the capture and sale of prizes provided an uncertain
flow of funds into the fund for two reasons. First, the actual capture
of prizes depended on the current international military and political
situations, not to mention the skill of American seamen. Second, once
the prizes were taken, they had to be sold and the proceeds returned to
the fund in accordance with the law. The latter condition often proved
as uncertain as the former, as shown in the fund's annual reports.
For example, in January 1816, the commissioners wrote:
The prize monies that provided the basic capital of the fund were
not consistently reported, but the data available show great
irregularity and extreme variance from year to year. The irregularity of
the flow of prize money manifested itself in an audit entitled
"Statement of the Condition of the Navy Pension Fund," issued
in 1829 (American State Papers, Naval Affairs, vol. 3, report no. 390,
Feb. 20, 1829, 323). Between 1814 and 1828, the fund received
$451,694.51 from the sale of prizes. Peak years of annual revenues were
1814 with $150,367 and 1819 with $174,848; however, no revenues at all
were received during six of the fifteen years. A basic portfolio
strategy would be to convert the prize proceeds into a regular income
flow to match the somewhat more regular payments to pensioners. With a
buy-and-hold strategy for government securities redeemed at par, capital
gains and losses would depend on whether the original assets were bought
at a premium, yielding a loss, or at a discount, yielding a gain.
Annual reports of the fund vary in their date of submission between
September and the following January, and vary considerably in detail
regarding vouchers. The 1824 report was not submitted, but it was
finally made available in 1828, having been reconstructed well after the
event. Income from the fund sometimes confused reimbursements with
interest received, and in several years the dividends paid by bank
stocks were neither received nor recorded to the credit of the fund. The
results of the reported periodic and special audits differ from the data
in the annual reports. Curiously, the quality of the financial data is
probably better for the earlier reports than for the later ones.
The portfolio from 1800 through 1808 was invested in U.S.
government stocks, representing a mix of coupon amounts among the Sixes,
Eights, and Threes, the last sort being first purchased in 1806. (The
names of the securities refer to their coupon rates.) Although the
Threes had a lower coupon, the price at Philadelphia in 1805-6 ranged
between $59.00 and $64.00, representing a current yield of about 5
percent. The Navy Sixes were redeemed in 1807 and the proceeds invested
in the Louisiana Sixes and the Threes.
Interestingly, the Eights were redeemed in 1809 and the proceeds
invested in the stock of a local bank, the Bank of Columbia, which
represents the privatization we discussed above.(13) Additional shares
of Columbia Bank, as it was often called, were purchased in 1810, and
the stocks of Union Bank and Washington Bank were purchased in 1811 and
1812 in what appears to have been in each case an "initial public
offering." Over the period 1809-13, $89,703 was spent on these
local bank stocks, placing 44 percent of the fund's portfolio in
private, locally traded securities.
The fund grew rapidly between 1800 and 1813, from $26,552 to more
than $200,000, because of prize receipts and because annual income and
gains exceeded payments to pensioners. Plentiful opportunities existed
to buy nationally and internationally traded stocks (bonds) between 1809
and 1813; the U.S. debt alone was approximately $50 million. There is
some evidence that commercial banks in the area were paying dividends on
the order of 7 to 8 percent. The Bank of the United States paid annual
dividends from July 1792 through 1810 of more than 8 percent of par, but
the fund never held that asset. The fund's records of income from
investments are summarized in table 1. Columbia Bank paid dividends of
$3,730 in 1810, which produced a yield of 6.2 percent on the amount
invested, and the Union Bank and Washington Bank yielded similar
dividends.
The portfolio valuation calculations that led the commissioners to
forfeit liquidity and take on the added risk for the potential
additional 1 or 2 percent over bond returns from the three local bank
stocks seems unconventional. This observation is important, because the
fund ignored the stock of the Bank of the United States. The three bank
stocks were acquired in "half" shares and "whole"
shares. The subscription schedule for the initial capital in the banks
provided an arrangement not unlike a time-purchase plan for acquiring
the stocks. It is possible the market price was paid for an exchange, or
the purchases might have been arranged in some manner consistent with
the initial offerings of the capital stock. All of these and subsequent
transactions in bank stocks were handled by an agent, George MacDaniel,
and the privatization of the fund has the scent of insider trading.(14)
During the War of 1812, the fund more than doubled between 1813 and
1814, from $206,076 to $484,852.(15) By 1829, it had grown to almost $1
million. The assets purchased from 1814 through 1824 were concentrated
on the New Sixes issued to finance the War of 1812. Yet, there were
additional purchases of Bank of Columbia stock in 1815, 1818, and 1819,
bringing the total expenditures for Columbia Bank stock to $99,502.60.
As the authorized capitalization of Columbia Bank was $1 million, the
fund owned almost 10 percent of it. The fund's total holdings of
private securities in 1819 were $129,266 of the enlarged total portfolio
of $874,672; thus 15 percent of the portfolio was invested in private
stocks. Between 1819 and 1829, the Sixes and Deferreds were being
retired, along with some of the New Sixes, while the fund acquired the
new debt being issued by the Treasury in bonds bearing 4.5 percent and
5.0 percent coupon rates. At the end of 1829, the majority of the fund
was invested in those securities, with a lesser amount in the New Sixes
and the original Threes.
The Columbia Bank ceased accepting new business in 1823 and ended
all active operations in 1828. Although the fund continued to carry
Columbia stock as "assets" on its books, valued either at cost
or at par value, we have excluded those assets as of year-end 1824 in
table 1.(16) Recall from our earlier discussion that the acquisition of
private assets inevitably increased the risk of the fund's
portfolio. Now we see the downside of that decision. With the failure of
the Columbia Bank, the fund lost roughly 10 percent of its value.
Typically, one would expect the owners--ultimately, the fund's
beneficiaries, who after all would reap the rewards from any capital
gains on the assets--to absorb such a loss; but in this case they did
not. In July 1834, the fund received $167,164.40 to cover equity and
forgone interest and dividends "from the Treasurer of the United
States, for Columbia Bank stock purchased of the navy pension fund by
the United States, per act of Congress, approved 30th June 1834."
The fund's net: loss from the failure of the Columbia Bank was
$99,502.60. The difference of $67,661.80 must include forgone interest
(at 5.32 percent) since about 1822. In other words, the taxpayers bailed
the fund out, as Congress assumed the risk of privatization on behalf of
the taxpayers ex post facto. Not coincidentally, at exactly the same
time, Congress restored the "widows and orphans" benefits, as
detailed earlier.
From 1830 through 1840 the portfolio experienced a great deal of
shuffling, because almost all U.S. debt was being redeemed (for details,
see Clark, Craig, and Wilson 1998). Between 1829 and 1830, there was a
very large increase in the amount of the Threes and Four-and-a-halfs and
Fives being held as the last of the New Sixes were redeemed. In 1829,
some municipal stock in the Washington Corporation, which went under
various names over a few years, had been bought. In 1832, as the Threes
were being redeemed, the fund made large purchases of stock of the
Second Bank of the United States, in compliance with directions by the
navy.(17) As noted earlier, the restriction of purchases to the Second
Bank of the United States was related to the failure of Columbia Bank
and also to the practice of paying commissions to agents of the fund
while they were on the payroll as disbursors of pension payments. The
navy direction followed several audits and much correspondence from the
fund for reimbursement because of inability to pay benefits to the
widows and orphans. Also, state bonds of Maryland and Pennsylvania had
been acquired, along with the local debt of Cincinnati, all of which
paid a 5 percent coupon.(18) Indeed, practically all stocks ever
purchased by the fund were at a premium, except the Threes, which
typically traded at a discount because of their "less than
market" coupon. In 1838 Illinois bonds and a small additional
amount of local debt in Washington were added to the portfolio.
Over the period 1830-36, the total amount of the portfolio remained
rather constant in the neighborhood of $1 million, but it fell sharply
by 1838 to $390,832, as stocks had to be sold to meet the fund's
increased pension obligations. Interestingly, after its federal charter
expired in 1836, the Second Bank of the United States was rechartered in
Pennsylvania. It eventually failed and was liquidated on February 4,
1841. From October 1, 1837, through the end of September 1838, however,
the fund received $510,353.90 in principal and interest from the
Treasury as compensation for the bank's stock.(19) In addition to
these problems, several states defaulted on their debts, and interest
rates on state debt climbed to more than 15 percent as the prices of
state bonds fell (Sylla and Wallis forthcoming). This collapse occurred
as the fund was selling securities to meet pension obligations, and the
value of the portfolio went from $253,139 at the end of 1839 to virtual
depletion at the end of 1841. The only assets remaining in the fund were
shares of the Union Bank and the Washington Bank, which were nearly
worthless.
Conclusion
The history of the U.S. Navy pension fund and its management
demonstrates that the privatization of the fund exposed it to additional
risk. Once the fund realized the downside variability that characterizes
such risk, Congress simply shifted the risk to taxpayers and bailed out
the fund--on two different occasions. This episode offers a valuable
lesson for contemporary debates about the privatization of the Social
Security system. Specifically, it demonstrates the legislators'
inability to credibly ensure that the risks associated with the greater
expected returns from privatization were similarly privatized.
Ultimately that congressional failure to link risk and return caused the
support of the pensioners to be thrown back on the taxpayers. We have
little reason to suspect that a similar fate would not befall such an
attempt in our own time.
(1.) In this article we use the term "privatization'
synonymously with "investing in the equity or liabilities of
private corporations." Although this meaning is not always what
people have in mind when using the term privatization, we believe the
gains from concision outweigh any resulting confusion.
(2.) Another concern, not considered here, is the risk that because
of the government's tendency to respond to political rather than
market forces the value of the firms in which the government owns a
stake could be driven below their free-market value. On the other hand,
the government might employ its powers to artificially drive up the
value of firms in which it has a stake at the expense of potential
competitors and perhaps taxpayers.
(3.) American Express established the first formal
employer-provided pension plan in the United States in 1875, and by the
turn of the century a handful of private companies, mainly railroads,
had added such plans (Latimer 1932). Although a few municipalities
provided pensions to police officers, firefighters, and teachers, the
first plan for state employees was established by Massachusetts in 1911,
and the federal civil-service pension plan was created in 1920 (Craig
1995).
(4.) The 1800 legislation, designated an "Act for the Better
Government of the Navy of the United States," specified that the
commissioners of the pension fund must provide annual reports to
Congress on the operations of the fund. Those reports provide
information on the activities of the pension fund and are the primary
source of data employed in this article.
(5.) In June 1812, Congress created a similar fund for privateers.
The fund, to be supervised by the secretary of the navy, would receive 2
percent of all U.S. prize money. It was depleted in 1837.
(6.) Through 1836 these data are from the various annual reports by
the commissioners of the navy pension fund; thereafter, they are from
the annual reports of the secretary of the navy, which were required by
Congress.
(7.) The estimates of extraordinary payments are largely back
benefits as required by subsequent legislation (described later).
(8.) On the rent-seeking advantage of small, well-defined groups,
see Olson (1965, 53-65). The success of federal workers in such
activities is detailed in Johnson and Libecap (1994, 126-48). For a
survey of empirical studies documenting this phenomenon for
public-sector workers in general, see Mueller 1989, and on federal
pensions in particular, see Craig 1995. the commissioners, who were also
the trustees of the fund, lamented Congress's improvident expansion
of benefits:
(9.) In the annual report filed in January 1816, the commissioners
concluded that limiting the benefit to half pay "proved inadequate
to the maintenance of disabled seamen and marines, particularly the
latter, which cannot exceed three dollars per month. The extension of
the law, so as to vest in the commissioners a discretionary power to
allow, in extreme cases, to the full amount of monthly pay, or otherwise
to provide for the necessary subsistence of those who are totally unable
to take care of themselves, would, it is believed, obviate causes of
complaint, and reflect honor upon the liberality and justice of the
National Legislature" (American State Papers, Naval Affairs, vol.
1, report no. 134, Jan. 9, 1816, 381).
(10.) Note that the figures in column 1 of table 1 include only
interest- or dividend-earning assets. The cash holdings of the fund are
unavailable; thus, for example, the dip in the fund's value in 1828
appears to be simply the result of a temporary increase in the
fund's cash position.
(11.) The 1839 report of the secretary of the navy also noted that
the second section of the act of 1837 contributed to increased
expenditures from the fund. "The section of the same act provides,
that `pensions which have been granted, or which shall here after be
granted to officers, seamen, and marines, in the naval service, disabled
by wounds or injuries received in the line of their duty, shall commence
from the time when they were disabled.'"
(12.) For the details of the management of the fund's
portfolio, see Clark, Craig, and Wilson 1998.
(13.) The ownership and control of the Columbia Bank read like a
who's who of the early republic. George Washington was a
stockholder, as was Henry "Light Horse Harry" Lee, a hero of
the Revolution and the father of Robert E. Lee. Among the early
directors were William Marbury, the plaintiff in Marbury v. Madison, and
Francis Scott Key. A founder and the second president of the bank,
Benjamin Stoddert, was the first Secretary of the Navy (Cole 1959, chap.
3; Walsh 1940, 59-93).
(14.) It was probably not a coincidence that among the directors of
the bank was one John MacDaniel, Jr., though we have not yet made a
connection between the two MacDaniels; the relationship among the
leading families of Georgetown resembled that in New England, documented
by Lamoreaux (1986). Elsewhere we explore the potential malfeasance
attending the management of the fund (Clark, Craig, and Wilson 1998).
(15.) The fund's holdings are reported in detail in Clark,
Craig, and Wilson (1998), available from the authors on request.
(16.) The exact nature of the failure of the Bank of Columbia
remains something of a mystery, but evidence suggests at least three
reasons: (1) poor management, (2) bad real-estate loans in the District,
and (3) a misguided effort to serve as a collection agent for the Second
Bank of the United States (Cole 1959, chap. 3; Walsh 1940, 59-93). Of
the thirteen banks chartered in the District of Columbia by 1830, four
had failed (Gallatin 1831, 99, 104).
(17.) This stock was purchased from the Treasury at par with no
fees involved. The transactions represent subsidies, because the stock
was trading at a premium at that time.
(18.) These stocks were bought at a premium (Clark, Craig, and
Wilson 1998).
(19.) No Bank of the United States stock appears among the
fund's assets after 1837 (Clark, Craig, and Wilson 1998). We do not
know exactly how those shares were disposed of, though it is possible
they were sold by the Treasury.
References
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647-68.
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Lebergott, Stanley. 1964. Manpower in Economic Growth: The American
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Olson, Mancur. 1965. The Logic of Collective Action: Public Goods
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Seybert, Adam. [1818] 1969. Statistical Annals. Reprint, New York:
Burt Franklin.
Smith, Walter. 1953. Economic Aspects of the Second Bank of the
United States. Cambridge, Mass.: Harvard University Press.
Sylla, Richard E., and John J. Wallis. Forthcoming. The Anatomy of
Sovereign Debt Crises: Lessons from the American State Defaults of the
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Sylla, Richard E., Jack W. Wilson, and Robert E. Wright. 1997.
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Acknowledgments: The authors thank Lee Alston, Gary Libecap,
Richard Sylla, workshop participants at Ball State University, the
Triangle Universities' Economic History Workshop, and the Labor
Workshop at North Carolina State University, and two anonymous referees
for helpful comments and suggestions. In addition, the authors thank Bob
Wright for research assistance, and Ms. Jean Porter of the D. H. Hill
Library at North Carolina State University for diligent assistance in
locating many of the original sources cited in the paper. This research
has been partially funded by a grant from TIAA-CREF.
Robert L. Clark, Lee A. Craig, and Jack W. Wilson are faculty
members in the College of Management at North Carolina State University.
Year Fund(a,b) Annual Number of Annual
Investment Returns Pensioners Outlays
(dollars) (dollars) (dollars)
1800 26,552 489 -- --
1801 56,556 4,748 22 1,605
1802 79,056 5,485 -- --
1803 126,325 8,457 37 3,567
1804 129,712 9,147 37 3,261
1805 164,595 10,478 49 4,413
1806 165,963 13,364 65 5,298
1807 177,344 14,206 78 6,396
1808 175,460 14,407 85 6,863
1809 220,397 11,341 90 6,671
1810 192,809 14,821 93 7,043
1811 206,076 15,967 107 8,045
1812 210,701 17,204 122 9,287
1813 206,076 10,896 148 11,273
1814 484,852 31,392 176 13,667
1815 598,557 39,255 252 20,547
1816 594,041 32,589 327 27,627
1817 724,950 52,153 358 32,036
1818 877,236 57,221 -- 34,970
1819 874,672 57,739 438 39,340
1820 870,862 52,330 480 43,863
1821 891,895 53,338 491 44,488
1822 906,662 52,654 431 38,772
1823 910,515 49,016 423 37,248
1824 819,436 46,340 524 --
1825 900,166 49,606 524 --
1826 917,902 47,482 533 49,653
1827 911,252 47,519 534 --
1828 642,633 40,569 570 --
1829 950,675 36,204 596 --
1830 967,081 42,406 536 31,938
1831 1,003,880 34,476 536 --
1832 937,047 37,465 -- --
1833 947,545 52,443 -- --
1834 1,142,462 50,000(c) -- --
1835 1,160,162 50,000(c) 442 54,083
1836 1,143,639 50,886 466 58,009
1837 1,049,232 -- 678 87,768
1838 390,832 -- 847 103,120
1839 253,139 -- 901 110,123
1840 158,739 -- 914 108,750
1841 23,600 -- 959 113,903
1842 -- -- 946 107,129
Year Per Capita Outlays
(dollars)
Ordinary Extraordinary(a)
1800 -- --
1801 72.95 --
1802 -- --
1803 96.40 --
1804 88.13 --
1805 90.06 --
1806 81.51 --
1807 82.00 --
1808 80.74 --
1809 74.12 --
1810 75.73 --
1811 75.19 --
1812 76.12 --
1813 76.17 --
1814 77.65 --
1815 81.54 --
1816 84.49 --
1817 89.49 --
1818 -- --
1819 89.82 --
1820 91.38 --
1821 90.61 --
1822 89.96 --
1823 88.06 --
1824 -- --
1825 -- --
1826 93.16 --
1827 -- --
1828 -- --
1829 -- --
1830 59.58 --
1831 -- --
1832 -- --
1833 -- --
1834 -- --
1835 122.36 --
1836 124.48 --
1837 129.45 296.00
1838 121.74 255.06
1839 122.22 247.55
1840 118.98 242.53
1841 118.77 236.52
1842 113.24 232.61It will be perceived that, by the act of 1834, a pension is allowed to the
widow of every person who may die in the naval service by reason of disease
contracted while in his line of duty; a phrase than which nothing can be
more vague or more liable to abuse, and which is nearly tantamount to
authorizing a pension to be granted to the widow of every person who may
die in the naval service. To such an extension of the pension system, the
committee are decidedly opposed. (American State Papers, Naval Affairs,
vol. 4, report no. 616, Mar. 21, 1836, 863)
arrearage of pensions for more than thirty-seven years, in one instance
involving the payment of more than $20,000, have been paid under this
section which has mainly caused the rapid diminution of a fund originally
constituted for the sole purpose of providing for officers and seamen only,
disabled in naval service.(11)
It is therefore certain that at the end of two years, at the farthest, the
navy pension fund will be exhausted. Under the existing laws there is not
the least prospect of any decrease in the number of pensioners or the
amount of their pensions; and consequently, Congress will be called upon to
... make good any deficiency in the navy pension fund arising out of its
own legislation. (U.S. Senate 1839)
[We] find it necessary to claim the further aid of the Legislature, not
only to enable them to collect the arrearage of the prize money, which
belongs to the fund, but to secure, in future, a punctual and faithful
accountability on the part of those officers who are charged with the
prosecution and sale of prizes, and the collection and distribution of the
proceeds of the sales. The imperfections of the existing laws are great,
and have given rise to many abuses. (American State Papers, Naval Affairs,
vol. 1, report no. 134, Jan. 5, 1816, 380)