Pensions

American Society / Banking / Financial / Housing / Pensions / The Federal Reserve — 0 Comments
5
Apr 11

Rates Are Low, Morals Are Lower

Monday, the Wall Street Journal awakened to “discover” the plight of the elderly: Fed’s Low Interest Rates Crack Retirees’ Nest Eggs by Mark Whitehouse.  The Journal describes elderly Americans, who worked all their lives and saved what they thought were sufficient funds to live out their remaining years in comfort. With the Federal Reserve’s zero interest rate policy retirees are realizing miniscule returns on their savings. They must therefore resort to spending their principal and cutting back on all expenditures.  Some examples of this new reality:

Forrest Yeager, a 91-year-old resident of this seaside community, had been counting on his retirement savings to last until he died. The odds are moving against him. With short-term bank CDs paying less than 1%, the World War II veteran expects his remaining $45,000 stash to yield just a few hundred dollars this year. So, he’s digging deeper into his principal to supplement his $1,500 monthly income from Social Security and a small pension.

“It hurts,” says Mr. Yeager, who estimates his bank savings will be depleted in about six years at his current rate of withdrawal. “I don’t even want to think about it.”  See Fed’s Low Interest Rates Crack Retirees’ Nest Eggs.

Most recent (2009) Labor Department data  show that annual investment income over the last two years examined for 24.6 million households headed by a person 65 and over has fallen 37 % to a meager $2564.    In 2010, 33% of retirees dipped into savings to pay living expenses.

Hand Wringing

At this time, investing in short-term certificates of deposit, time deposits and money market funds would yield .24% annually, one-tenth the level of late 2007.  Inflation is now running at an annualized rate of 5.6%.   Richard Fisher, President of the Dallas Federal Reserve is quoted in the article:

“Americans who have done everything right, have worked hard, saved their money and stayed out of debt are the ones being punished by low interest rates,” says Richard Fisher, president of the Federal Reserve Bank of Dallas and a voting member of the Fed’s policy-making open market committee. “That state of affairs is not sustainable for a long period of time.”  See Fed’s Low Interest Rates Crack Retirees’ Nest Eggs

While recognizing the problem, Mr. Fisher’s comments strike me as surrealistic and disingenuous in the extreme.  Why is he hand wringing when he, more than most others, can effect change?  He is a voting member of the Federal Reserve!  In his position of influence, he can actually change the insane policies of the Fed.

Our Golden Years?

What are senior citizens doing to get by?  Mr. Whitehouse’s article lists a number of changes he is observing in financial behavior:

  • Investing in the stock market, even though much retirement saving has been devastated in the last two bear markets (2000, 2008)
  • Shopping at thrift shops and eating in subsidized community centers
  • Cutting or eliminating all other expenses such as movies or hobbies
  • Invading principal for living expenses

Re-entering the workforce is not an option for most retirees, as jobs are more scarce, or a senior age candidate may have more physical limitations on their employment options.

Unintended Consequences

The Journal recognizes that zero interest rate have been a windfall for the banks at the expense of the elderly.   All savers are hurt by the zero interest rate policy, but that is the obvious consequence.

Low rates don’t just hurt retirees. They also penalize people of any age hoping to build up funds for the future, and discourage rainy-day savings that could make U.S. consumers more resilient to job losses and other financial jolts. Americans’ net contributions to their financial assets, such as bank and 401(k) accounts, amounted to 4% of disposable income in 2010, according to the Fed. That’s the lowest level since it began maintaining records in 1946—except for 2009, when people actually pulled money out. See Fed’s Low Interest Rates Crack Retirees’ Nest Eggs

No wonder we have a sluggish economic recovery: we have no new savings to invest in the economy.  Further, if we want housing prices to recover, how does a young couple develop sufficient savings for a house down payment?

Return to Sanity

Zero interest rate policies punish the elderly in two ways: reducing personal income, and driving up basic need cost, such as food and energy.  Expecting the elderly to reenter a workforce that already has too many unemployed and underemployed individuals is absurd.  We are punishing that part of society who played by the rules: they worked hard, lived within their means, paid off their mortgages and saved for retirement.  Unfortunately, the Federal Reserve and the Obama Administration decided to reward the banks who made ridiculous loans, created fraudulent mortgage backed securities, overpaid their executives and nearly crashed the entire financial system.  Where is the morality of favoring the profligate over the thrifty?

Mr. Fisher and his colleagues could end the insanity tomorrow.  Stop the Federal Reserve’s interventions in the financial markets and let the market determine the true rate of interest.  Savers everywhere, elderly or not, will thank you.

 

 

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Banking / Financial / Municipal Finance / Pensions / State Finance — 0 Comments
22
Oct 10

Elements of an Unstable Financial System

We are currently caught up in the day to day gyrations of the stock, bond or foreign exchange markets.   Politicians tell us that we are recovering, but we just need more stimulus packages and investment tax credits.   The Federal Reserve proudly takes credit for “the recovery.”  They maintain we have avoided a depression, but at the same time report monthly that we need interest rates at zero indefinitely.  Members of the Federal Reserve and the financial press strongly hint that we need a second round of quantitative easing (the monetizing of debt), even though this program ended in March 2010.

This highly unstable financial system threatens to wreck the economy, deplete retirement savings and imperil democracy.  This is not hyperbole.  Let’s examine the indicia of instability:

  • A Failing Banking System – So far this year, 120 banks have failed.  This is well ahead of last year’s failure rate.  As of August, 829 of a total of 7800 FDIC supervised banks were on a watch list.  A watch list indicates a high probability of bank failure.  The prior year 416 banks were on this list.   See FDIC Finds 829 U.S. Banks at Risk
  • Foreclosure-Gate – Poor documentation during the foreclosure process, ranging from false affidavits to improper notarizations to suspected forgeries, looms as the next big scandal.    All this will lead to the real issue of violation or representations of representations and warranties during the securitization process.  It has already led to financial participants attempting to return mortgage backed securities to their originating banks. See Pimco, Blackrock and New York Fed  Seek Bank of America Mortgage Putbacks. Other money center banks face similar demands.  For just Bank of America, Goldman Sachs analysts predict the put back liability could be as much as $25b.  Foreclosure-gate and the “put back wars” will tie banks up in expensive litigation for years with the prospect of large losses.  See Goldman on Total BofA Putback Losses:$25 Billion Which Apparently is a Good Thing
  • High Frequency Trading – Lightening fast computer trading now dominates daily stock exchange activity.  Trades are based on small pricing differentials rather than stock fundamentals.  On May 7th, the Dow Jones Industrial Average plunged 700 points in 5 minutes.   The SEC investigation attributed the crash to high frequency trading.  See Speed-Addicted Traders Dominate Today’s Stock Market
  • QE2 and Government Manipulation of Asset Prices – Brian Sack of the New York Federal Reserve has openly stated that the goal of the Federal Reserve is to put a floor under asset prices.  Thus, the government is deliberately targeting and manipulating stock prices. Moreover QE2, which is the Federal Reserve openly buying government debt, has inflationary and even hyperinflationary potential. See Managing the Federal Reserve’s Balance Sheet
  • Exodus of Retail Investors – Government manipulation, high frequency trading, wild market gyrations and economic circumstances have driven the retail investor from the stock market.  The Investment Company Institute reports the 24th consecutive weekly retail outflow from equity mutual funds.  This year to date $81b has been withdrawn. See 24th Consecutive Outflow from Domestic Stock Mutual Funds is in the Books
  • Currency Wars – Despite denials from Secretary Geithner, the Administration and the Federal Reserve have engineered a 10% decline in the dollar since June 2010.  Import prices have skyrocketed for resources such as oil.    This has triggered currency wars between nations.  Foreign governments have responded with attempts to depreciate their own currencies and impose capital controls. See As Currency Declines, Currency Conflicts Arise
  • OTC Derivatives – Various forms of derivatives (credit default, interest rate and foreign exchange instruments) were one of the culprits for the 2008 financial crisis.  The Bank for International Settlements estimates that $600T of these instruments are currently outstanding.  One expert estimates that losses could run from $12.5T to $20.5T in the next crisis, with many institutions defaulting higher losses.
  • Zero Interest Rate Policy – This is a two-edged source of instability.  Banks can borrow at zero percent and use the funds to speculate, confident that the government will cover their losses.  Earning little in safe investments, prudent savers are encouraged to spend or speculate with their dwindling savings. See Why is Charles Schwab the Only One Concerned About Zero Interest Rates?
  • Leverage – The Basel III agreements were intended to impose more stringent capital requirements.  The agreement permits banks to leverage their deposits 20 times.  In the past 12 times leverage was considered prudent. Said another way, a mere 5 percent decline in an investment position under Basel III would result in the entire position being negative. See Basel III Summary, and the Fed’s Endorsement of 20x+ Leverage
  • Sovereign Default – Ireland is only the latest victim of an unstable international financial system. Initially forced to adopt austerity measures, the government recently had to bail out an Anglo-Irish bank that had just passed the EU stress test.  See An Angry Ireland Calls Out Europe.  The specter of sovereign default still remains in Europe and experts have questioned the soundness of US debt.
  • Looming Bailouts – Underfunded pension plans and state and local governments’ running huge budget deficits are the next potential candidates for massive federal bailouts. See, e.g., Is a $1 Trillion Bailout Ahead of State Pension Funds?

Strange Brew

Lack of government regulation, poorly thought out government interventions,   mercantilist government policies, greed, and a myriad of other factors have created a strange brew.  Every day we witness violent swings in the fixed income, stock market and foreign exchange markets.  These gyrations have consequences in the real world as markets soar and crash.  Savers are also consumers and their incomes have been destroyed.  Consumers are threatened with higher food and energy prices.  There is no safe place to invest funds.  The success of the domestic economy depends on the whim of one man, Ben Bernanke.  It is no surprise that investors are fleeing financial markets, and that gold soars.

We are running headlong into Stein’s Law (named for Herbert Stein, Nixon and Ford’s chief economic adviser): “if something cannot go on forever, it will stop.”  But when these gyrations stop, probably sooner rather than later, we will be headlong into the next great financial crisis.

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American Society / Banking / British Society / Financial / Pensions — 0 Comments
29
Sep 10

True Confessions: A War on Savers

We have lived through the war on drugs and the war on poverty.  We now have a British government official admitting that we now have a war on savers.  Deputy Governor of the Bank of England Charles Bean told pensioners to stop moaning about low interest rates:

Older households could afford to suffer because they had benefited from previous property price rises….They should “not expect” to live off interest, he added, admitting that low returns were part of a strategy.

Savers shouldn’t necessarily expect to be able to live just off their income in times when interest rates are low. It may make sense for them to eat into their capital a bit…. very often older households have actually benefited from the fact that they’ve seen capital gains on their houses.   See Savers Told to Stop Moaning and Start Spending

Post crisis, savers in Britain are now averaging interest on their savings of less than a quarter percent (.023) as compared to just under three percent (2.8).  The response of groups representing pensioners is swift and angry.

National Pensioners Convention spokesperson Dot Gibson said:

“For years we’ve been told to put money aside for our retirement only to find that interest rates have sunk and now we have to use our savings just to pay the bills.” See Savers Told to Stop Moaning and Start Spending

Save Our Savers spokesperson Jason Riddle added:

“The Bank was aware that there was a lack of saving before the financial crisis, but those who were prudently saving while others spent, are being heavily punished.”  See Savers Told to Stop Moaning and Start Spending

The article calculates that savers have lost 18 billion British pounds due to low interest rates.

Elites Gone Wild

The political and financial elites have spun the truth to persuade the public to accept post-crisis bank prosperity at the expense of the real economy. But the truth has a funny way of rearing its ugly head and reasserting the plight of Main Street at the mercenary hands of Wall Street greed.   Last week Charles Munger, Vice Chairman of Berkshire Hathaway and partner of Warren Buffet, spoke at the University of Michigan.  He attempted to justify the bank bailouts and corporate guarantees:

“You should thank God” for bank bailouts, Munger said in a discussion at the University of Michigan on Sept. 14, according to a video posted on the Internet. “Now, if you talk about bailouts for everybody else, there comes a place where if you just start bailing out all the individuals instead of telling them to adapt, the culture dies.”

“Hit the economy with enough misery and enough disruption, destroy the currency, and God knows what happens,” Munger said. “So I think when you have troubles like that you shouldn’t be bitching about a little bailout. You should have been thinking it should have been bigger.”  See Berkshire’s Munger Says Cash-Strapped Should ‘Suck it In’ and Not Get Bailout

Mr. Munger fears that bailouts would lead to another Adolph Hitler.

Mr. Munger’s contempt and disdain for the middle class and working poor came out later in the Michigan session:

To another who asked whether the government should have bailed out homeowners instead of Wall Street, Munger said: “You’ve got it exactly wrong.” “There’s danger in just shoveling out money to people who say, ‘My life is a little harder than it used to be,’” Munger said at the event, which was moderated by CNBC’s Becky Quick.  “At a certain place you’ve got to say to the people, ‘Suck it in and cope, buddy. Suck it in and cope.”  See Berkshire’s Munger Says Cash-Strapped Should ‘Suck it In’ and Not Get Bailout

I am OK, You are Not

Bean and Munger have demonstrated the arrogance of the elites.  Is it alright for Berkshire Hathaway, which is heavily invested in the financial markets through significant stakes in Wells Fargo, Goldman Sachs and GE, to be bailed out by the government?  Should we, the “little people,” 25 million of whom are unemployed or underemployed, just “suck it up?”

Mr. Bean’s recommendation for financial survival is to tap into the capital gains on one’s home.  How does a pensioner do that?  Borrowing with no income to support the loan?  Selling the home, paying tax and moving where?    Take out a financially sketchy disadvantageous reverse mortgage?   Alternatively, go out and get a job when there is massive UK unemployment?

Mr. Munger laments that the bailouts to the banks were not in even higher amounts.  Neal Barofsky, inspector general for TARP, estimated that bailouts and guarantees were in excess of $23 trillion.  See Credit Ghettos.  Mr. Munger, how much more should have been handed out to Wall Street?   Why does that type of behavior not destroy the currency and lead to Munger’s feared re-run of the Weimar Republic and Hitler?

Munger and Bean demonstrate how out of touch the financial elites in Britain and America are with the plight of the middle class.  It also demonstrates how pernicious zero interest rates are for the middle class, pensioners and savers in general.  We have discussed the immorality of zero interest rates extensively.  See War on Prudence,  Nothing from Nothing, Is the Administration Determined to Make the Elderly Poor?

Luckily, in the United States we have the ballot box to effect change.  Last time the elites in Europe said “let them eat cake” change took place on a scaffold with a guillotine.

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American Society / Economics / Municipal Finance / Pensions / Political / State Finance — 0 Comments
11
Aug 10

Awash in Legacy Costs

Legacy costs have strangled many American iconic and venerable American industrial firms.  The automobile and steel companies are recent victims of this growing scenario:  diminishing work force and profits supporting large and growing pension and retiree medical costs.  In many instances bankruptcy has been the corporation’s only way out.

The Financial Dictionary defines legacy costs in the private sector as follows:

Ongoing costs to a company that come from funding activities that, by definition, do not increase revenue. Perhaps the most prominent example of legacy costs is the funding of pension plans. Legacy costs often accrue when a company takes on too many responsibilities in times of strong performance or when it takes on an appropriate level of responsibility and then its priorities change.

Legacy costs also include retiree medical, life insurance and other promised benefits.

The recent turmoil in the financial markets has revealed a potentially larger legacy problem.  Not only is private industry suffering this stranglehold; legacy costs are also drowning state budgets in red ink. Like private business, the public sector is also saddled with pension, retiree medical and life insurance benefits.   Completing the analogy, many of these costs were taken on when state tax revenues (think profits) were high.  Politicians avoided confronting public employees and unions and chose the path of least resistance; that is, they capitulated to exorbitant demands.  Then they compounded the problem:  instead of direct layoffs, states resorted to early retirement pension sweeteners, which depleted pension assets.

The Current Status of Public Pension Plans and Other Benefits

On August 6th, the New York Times reported the massive underfunding of public pensions.  See Battle Looms over Huge Cost of Public Pensions. The Times discovered a February Pew Center for States study showing a $1 trillion pension underfunding. (We could have a whole different post as to why it took until August for the Times to report a study published in February.)   Worse yet, the Pew study may have been overly optimistic.  In other words, their methodology understated the liability and the deficit.  In contrast, the National Center for Policy Analysis’ Unfunded Liabilities of State and Government Employee Retirement Benefit Plans found that states were using too high a discount rate to determine employee liabilities.  Under the National Center for Policy Analysis deficits are far more alarming:

  • Unfunded liabilities for health and other benefits are
    $558 billion, compared to the reported $537 billion.
  • Thus, total unfunded liabilities for all benefit plans are an
    estimated $
  • Unfunded pension liabilities are approximately $2.5
    trillion, compared to the reported amount of $493 billion.
  • 3.1 trillion — nearly three times higher than
    the plans report. See Reality Beckons (Government Pensions)

While pensions are funded, other benefits like retiree medical, vision and dental have no assets side aside to fund them.  Moreover, based on current trends, medical costs are growing exponentially.

The New Battle Ground

Colorado undertook modest changes to its pension plans to lower future pension payments. The state legislature reduced its cost of living adjustment cap from 3.5% to 2%. The result was an immediate lawsuit from public employees:

Earlier this year, in an act of rare political courage, a bipartisan coalition of state legislators passed a pension overhaul bill. Among other things, the bill reduced the raise that people who are already retired get in their pension checks each year.

This sort of thing just isn’t done. States have asked current workers to contribute more, tweaked the formula for future hires or banned them from the pension plan altogether. But this was apparently the first time that state legislators had forced current retirees to share the pain.

Sharing the burden seems to be the obvious solution so we don’t continue to kick the problem into the future. See Battle Looms over Huge Cost of Public Pensions

Employees view their pensions as inviolable contracts, while the state is invoking changes as actuarial necessities.

Who Thinks About the Taxpayers?

Taxpayers are facing unemployment, the risk of losing their jobs and increasing costs of education, medical and energy.   Public employees are well paid, largely insulated against layoffs, and receive top of the line current and retiree benefit packages.  Barron’s points out that: “[m]ost public employees, if they hang around to retirement, can count on pensions equal to 75% to 90% of their pay in their highest-earning years.”  The $2 Trillion Hole.  Frequently, supervisors and employees collude to inflate final pay with shift and overtime pay in the last year of work.  Current and retiree medical benefits require minimum or no contribution.

In contrast, private sector benefit plans pale in generosity to public benefit plans.  I worked for a company for 32 years and my pension is a little more than 40% of my last five years of pay.  Retiree medical requires a 20% contribution.   Our plans had no cost of living adjustments.   My company’s plans were probably in the top 5% of benefit plans in America.   Most companies offer little more than a basic medical plan and no retiree benefits.

The federal government will soon run out of borrowing capacity.  In addition, there are questions of federalism; that is, the states are supposed to be responsible for their own finances.   Federal and state legislators and public unions  have to be far more realistic than they have been.  If they are not,  some of our largest states (think New York, New Jersey, California, Illinois) will suffer as did  GM and  Greece:  drowning in legacy costs.

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Business / Financial / Pensions / Regulation — 0 Comments
15
Jul 10

Pension Insecurity

Substantial recent financial media focus has been lavished on subprime mortgages, credit derivative bets on a decline in the residential housing market, flash crashes in the stock market, bank insolvencies, major corporate bankruptcies, and sovereign debt defaults. They have paid less attention and provided less insight into the perilous state of pension funds.

Both public and private pension funds face an emerging crisis.  We need to examine some disturbing trends in both sectors.

New Jersey Pension Fund Crisis

In No Garden-Variety Pension Crisis, Andrew Briggs asks hard questions about the funding of New Jersey’s public pension plans.  If the state used private sector pension accounting, the underfunding would rise from an already horrendous $46b to a mindboggling $170b.  This deficit is more than five times the 2011 $29.4b state budget.

The real question is, when will the plan run out of money?  Assuming the plan can earn 8%, which may be an aggressive assumption in the current environment, the plan would run out of money in 2019.  However, NJ has increased its risk profile for the fund.  The state has moved 60% of its pension assets into riskier alternative investments, such as hedge funds and private equity.  Thus, there is a 25% chance the fund can run out of money as early as 2017.

The article concludes that NJ is not alone.  Connecticut, Indiana, Illinois and other states are due to run out of money before the end of the decade.  (See Bailout Nation Lives: Revisited, a Short Update).

Diageo

And while we are worried about risky funding strategies utilizing hedge funds and private equity, pension funding creativity reaches new heights with a plan by the Diageo Corporation. This beverage conglomerate intends to “fund” its plan with more than 2 million barrels of scotch whiskey.

Diageo said … it would transfer ownership of £430 million, or $645 million, worth of whiskey to a pension funding partnership. Diageo employees would not receive their pensions in whiskey rather than cash, but the move does give them a guarantee that they would not walk away empty-handed should the company default.

“A pension funding partnership will be formed, which will hold maturing whiskey spirit as assets,” ….

As part of the deal, Diageo agreed to pay the pension partnership £25 million a year as it sells the recently distilled whiskey once it matures after three years and replaces it with new stock. The agreement would expire after 15 years, at which point Diageo would buy back the whiskey, which comes from distilleries such [as] sic Oban on the west coast of Scotland. See Diageo Uses Scotch to Plug Gap in Pension Plan.

I personally love Diageo products.  Talisker, Lagavulin, Oban and others are some of the finest whiskies in the world.  See Tis’ the Season for Deflation and Update on Deflation. In my prior posts on Diageo, I pointed out that some of their premium products were in dramatic price decline.  Now it becomes clear that weak pricing power and pension underfunding for Diageo are connected.  If Diageo had pricing power, it would have sufficient profits to fund its pension plan with cash.  In a deflationary world, should their pension plan beneficiaries hope to count on the future price of scotch whiskey in order to receive their benefits?

GM, A Cautionary Tale

We have seen innovate funding techniques before.  In 1993, GM asked federal pension regulators to approve an innovative plan to meet a $24b pension deficit.

Under the plan announced today, GM would contribute shares of its class E common stock to the pension plan. The value of that stock is tied to the performance of a wholly owned subsidiary, Electronic Data Systems. Its closing price today on the New York Stock Exchange was $31; based on that price, the total value of the contribution would be $5.7 billion.  See G.M.Acts to Secure Pension Using Stock.

Regulators acceded to the GM request.  The rest is economic history:   GM recently went bankrupt, and the plans remain massively underfunded.

Poverty Follows Financial Innovation

In its time of pension deficit, Diageo is not the only creative funder. The UK is rife with new schemes:

The British supermarket chain J Sainsbury said earlier this year it would transfer property into a pension vehicle, while Whitbread agreed to hand over a share in its portfolio of restaurants and hotels. The investment firm Man Group moved some hedge fund assets into a trust as a security for its British pension plan in March.

“We’re seeing a huge growth in the use of non-cash funding,” Marc Hommel, leader of the pensions practice at PricewaterhouseCoopers in London, said. “There are big pension deficits and sponsors are cash-strapped. These mechanisms provide security for the pension plans in exchange for less cash.”  See Diageo Uses Scotch to Plug Gap in Pension Plan.

Mr. Hommel probably did not intend to be humorous, but one must ask whether these new methods of providing  “security” make the funds more or less secure.  I would submit that when one has to innovate and pull financial “rabbits out of the hat” both equity holders and pensioners of these companies face a lot more risk.  And so do we, the taxpayers and funders of our enormous public pension funds and guarantors of private pensions through the Pension Benefit Guaranty Corporation.

In this current age of funding gimmicks, maybe we should refer to pensions as a social insecurity system.

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