The Staggering Costs Of Bernankeism
by Martin Hutchinson July 23, 2012
http://www.prudentbear.com/index.php/thebearslairview?art_id=10688
The first, from Standard & Poor’s, outlined the yawning funding gulfs in U.S. private-sector pension schemes. The second, from the New York Fed, shows the astronomical growth in student debt. Both problems are likely to lead to huge costs in the future; neither would have occurred without Bernankeism.
The pension fund cost of Bernankeism is huge and growing—not shrinking. S&P showed that the unfunded pension liability of the S&P 500 companies reached a record level of $354.7 billion in 2011, an increase of over $100 billion from the end of 2010 and $50 billion higher than the figure at the bottom of the bear market in 2008. There’s an additional $223 billion in underfunding in “other post-employment benefits,” some of which is undoubtedly due to rising medical costs, but much of which must also derive from poor investment returns.
Until the last few years, pension-fund trustees could assume that the majority of underfunding was due to the sluggish stock market since 2000 and that a stock market recovery, combined with a modest increase in funding by the companies concerned, would eliminate the problem. However, the problem is much more fundamental than that. With interest rates at current levels, there is no way on God’s green earth that pension funds can earn the 7.5% to 8% returns that most actuaries have built into their calculations. The recent news that giant California state funds CalPERS and CalSTRS had earned only 1% and 1.8%, respectively, in the year ended June 2011, hopelessly beneath their actuarially assumed rates of return of around 7.5%, shows that the problem is not confined to the corporate sector. Indeed, the problem in the public sector, in federal, state and local governments, is an order of magnitude greater, with the U.S. Social Security system having the biggest actuarial deficit of all.
Stock market returns are over the long term fundamentally related to the cost of money. If money is very cheap, as it has been since 2008, then even in an ultra-sluggish economy corporate profits will be very high, as will stock market levels (in relation to the unattractively performing economy). That will reduce the level of returns that stock market investments can expect to command in the future. In 1990-2010, bonds yielded around 4.5% on average, while stock market returns averaged around 7.5%.Today, with bond yields below 2% for 10-year Treasuries, stock market returns can be expected to be only around 5%. Moody’s recently announced that it would value pension obligations using an assumed rate of return of 5.5%; that still seems a touch too high since pension funds invest in a mixture of bonds and stocks.
If pension funds put any reasonable proportion of their money in bonds yielding 2% (which to some extent they have to, for liquidity reasons), their chances of making 7% to 8% returns overall are negligible. Many pension fund trustees have in the last few years sought to hide this unpleasant truth by investing in “alternative assets” such as private equity, hedge funds and timberlands. As is becoming increasingly clear, however, private-equity investments and hedge-fund investments are unable to achieve superior returns to the public market over the long run; they merely involve their investors in much higher risk, much lower liquidity and hugely higher management charges, which inevitably come out of the pockets of the funds investing in them. As a Harvard man, I instinctively knew the “Yale Model” involving much higher alternative asset investment was rubbish; this is why.
Thus Bernanke’s policy of keeping interest rates far below even the modest current rate of inflation and using “non-traditional means” to drive long-term rates down even further below their natural level has caused an increasingly desperate if slow-moving crisis in the U.S. pension fund industry, both in the public and private sectors. However, the full cost of Bernankeism ranges far beyond the area of defined-benefit pension funds. While these have actuaries, and must report the holes in their funding to the world, the pension changes occurring since the 1990s have simply transferred the massive retirement funding risk to individuals. The inadequate funding of pensions has in those cases become inadequate funding of savings; the stern admonitions from the Pensions Benefit Guaranty Corporation have become gloomy days staring at a 401(k) savings plan that is hopeless to fund a reasonable retirement. What’s more, when the unfortunate plan-holder inquires from his plan provider what the inadequate amount of money will buy him as an annuity, he will be even more shocked, since ultra-low annuity rates mean that even sums of money that appear quite substantial buy annuities that are pathetic in their inadequacy.
A recent survey of baby boomers conducted by the builder Pulte Group showed that 61% planned to retire within 10 years, that only 14% said they would be financially unprepared to do so, and that 59% said they would not postpone retirement and might accelerate it. While the survey showed one encouraging trend, that boomers planned to retire at an average age of 67, compared with 63 20 years ago, the overall trend of the survey was relentlessly positive about baby boomer finances. Interestingly the survey also said that baby boomers feel on average 15 years younger than they are—which suggests that baby boomers are, on average, delusional.
Baby boomers who are approaching their relatively late retirement at 67 with $500,000 no doubt feel they are in pretty good shape. They will awaken from their reverie when they discover that one typical insurance company quotes that amount as purchasing an annuity of only $2,966 per month ($2,755 for women) with no pension for the surviving spouse or guaranteed minimum payout period. Doubtless, most baby boomers faced with this shock will opt not to annuitize, hoping that between 67 and 74 or so, when their money runs out, they will graduate from feeling 15 years younger than their actual age to being dead, solving the problem. Delusional, as I said, but one can hardly blame them. The poor souls are victims of Bernanke’s ultra-low interest rates.
I have already discussed the Bernanke policies’ adverse effect on savings, and the consequent de-capitalization of the U.S. economy. By this means, the United States’ immense capital cost advantage against emerging markets has been eroded. Since the superiority of U.S. educational institutions is for the most part questionable at best, there is now little to prevent U.S. living standards being driven inexorably down towards those of China or India. Just as baby boomers may face the problem of a penurious old age thanks to Bernanke’s policies, younger Americans may face diminished earning ability or high unemployment or very probably both. Both the “stickiness” of wages on the downside and the ham-fisted and expensive attempts by politicians to solve the problem are likely to make the inevitable decline in living standards even worse than it needs to be.
There is, however, a further problem of Bernankeism for younger Americans, which is only just heaving into view. The Federal Reserve Bank of New York recently produced a study of the student loan market, which showed that total loans outstanding were nearing $1 trillion, having more than doubled since 2005, and that the delinquency rate on those loans had risen above 10%. There are policies other than Bernanke’s that have caused this sudden explosion of debt. In particular, the 2005 Bankruptcy Act took the extraordinary step of making it impossible to extinguish student loans in bankruptcy, thus making student loans much more attractive bank assets than other consumer debt. The decision by government to guarantee a much higher proportion of student loans, thus removing their risk from banks, was also important. However, the crucial factor in their expansion was the Fed’s sloppy interest-rate policies, which made it ultra-attractive to banks to expand their balance sheets with student lending, knowing that even though there would be many defaults, the government would bail them out.
It is now becoming clear that the vaunted improvement in living standards caused by a college degree was largely the result of a booming economy and the generally superior cognitive abilities of those attending college. In the long downturn, with labor readily available, only those college graduates with specific skills have found their services in demand, and many who have spent $100,000 or more on their educations have found themselves waiting tables or worse. The hopelessness of many student loan problems is illustrated by the $180-odd billion of student debt owed by people of 40-49, with an average loan outstanding of close to $30,000 and a delinquency rate of close to 15% and rising. For those people, student debt is not a rite of passage of early adulthood, to be worked off as earnings rise with experience; it is a permanent millstone that will merge seamlessly into their pathetic attempts to save adequately for retirement.
The benefits of Bernanke’s short-termism have long since worn off; four years after the financial crisis, the long run has arrived. However, its costs will be with the vast majority of Americans throughout their lives, in excessive student loans in early adulthood, in unemployment and earnings suppressed by emerging-market competition against a decapitalized United States, in savings that can never keep up with inflation and in retirements subsisting on a diet of cat food. Truly the man has a lot to answer for.
by Martin Hutchinson July 23, 2012
http://www.prudentbear.com/index.php/thebearslairview?art_id=10688
The first, from Standard & Poor’s, outlined the yawning funding gulfs in U.S. private-sector pension schemes. The second, from the New York Fed, shows the astronomical growth in student debt. Both problems are likely to lead to huge costs in the future; neither would have occurred without Bernankeism.
The pension fund cost of Bernankeism is huge and growing—not shrinking. S&P showed that the unfunded pension liability of the S&P 500 companies reached a record level of $354.7 billion in 2011, an increase of over $100 billion from the end of 2010 and $50 billion higher than the figure at the bottom of the bear market in 2008. There’s an additional $223 billion in underfunding in “other post-employment benefits,” some of which is undoubtedly due to rising medical costs, but much of which must also derive from poor investment returns.
Until the last few years, pension-fund trustees could assume that the majority of underfunding was due to the sluggish stock market since 2000 and that a stock market recovery, combined with a modest increase in funding by the companies concerned, would eliminate the problem. However, the problem is much more fundamental than that. With interest rates at current levels, there is no way on God’s green earth that pension funds can earn the 7.5% to 8% returns that most actuaries have built into their calculations. The recent news that giant California state funds CalPERS and CalSTRS had earned only 1% and 1.8%, respectively, in the year ended June 2011, hopelessly beneath their actuarially assumed rates of return of around 7.5%, shows that the problem is not confined to the corporate sector. Indeed, the problem in the public sector, in federal, state and local governments, is an order of magnitude greater, with the U.S. Social Security system having the biggest actuarial deficit of all.
Stock market returns are over the long term fundamentally related to the cost of money. If money is very cheap, as it has been since 2008, then even in an ultra-sluggish economy corporate profits will be very high, as will stock market levels (in relation to the unattractively performing economy). That will reduce the level of returns that stock market investments can expect to command in the future. In 1990-2010, bonds yielded around 4.5% on average, while stock market returns averaged around 7.5%.Today, with bond yields below 2% for 10-year Treasuries, stock market returns can be expected to be only around 5%. Moody’s recently announced that it would value pension obligations using an assumed rate of return of 5.5%; that still seems a touch too high since pension funds invest in a mixture of bonds and stocks.
If pension funds put any reasonable proportion of their money in bonds yielding 2% (which to some extent they have to, for liquidity reasons), their chances of making 7% to 8% returns overall are negligible. Many pension fund trustees have in the last few years sought to hide this unpleasant truth by investing in “alternative assets” such as private equity, hedge funds and timberlands. As is becoming increasingly clear, however, private-equity investments and hedge-fund investments are unable to achieve superior returns to the public market over the long run; they merely involve their investors in much higher risk, much lower liquidity and hugely higher management charges, which inevitably come out of the pockets of the funds investing in them. As a Harvard man, I instinctively knew the “Yale Model” involving much higher alternative asset investment was rubbish; this is why.
Thus Bernanke’s policy of keeping interest rates far below even the modest current rate of inflation and using “non-traditional means” to drive long-term rates down even further below their natural level has caused an increasingly desperate if slow-moving crisis in the U.S. pension fund industry, both in the public and private sectors. However, the full cost of Bernankeism ranges far beyond the area of defined-benefit pension funds. While these have actuaries, and must report the holes in their funding to the world, the pension changes occurring since the 1990s have simply transferred the massive retirement funding risk to individuals. The inadequate funding of pensions has in those cases become inadequate funding of savings; the stern admonitions from the Pensions Benefit Guaranty Corporation have become gloomy days staring at a 401(k) savings plan that is hopeless to fund a reasonable retirement. What’s more, when the unfortunate plan-holder inquires from his plan provider what the inadequate amount of money will buy him as an annuity, he will be even more shocked, since ultra-low annuity rates mean that even sums of money that appear quite substantial buy annuities that are pathetic in their inadequacy.
A recent survey of baby boomers conducted by the builder Pulte Group showed that 61% planned to retire within 10 years, that only 14% said they would be financially unprepared to do so, and that 59% said they would not postpone retirement and might accelerate it. While the survey showed one encouraging trend, that boomers planned to retire at an average age of 67, compared with 63 20 years ago, the overall trend of the survey was relentlessly positive about baby boomer finances. Interestingly the survey also said that baby boomers feel on average 15 years younger than they are—which suggests that baby boomers are, on average, delusional.
Baby boomers who are approaching their relatively late retirement at 67 with $500,000 no doubt feel they are in pretty good shape. They will awaken from their reverie when they discover that one typical insurance company quotes that amount as purchasing an annuity of only $2,966 per month ($2,755 for women) with no pension for the surviving spouse or guaranteed minimum payout period. Doubtless, most baby boomers faced with this shock will opt not to annuitize, hoping that between 67 and 74 or so, when their money runs out, they will graduate from feeling 15 years younger than their actual age to being dead, solving the problem. Delusional, as I said, but one can hardly blame them. The poor souls are victims of Bernanke’s ultra-low interest rates.
I have already discussed the Bernanke policies’ adverse effect on savings, and the consequent de-capitalization of the U.S. economy. By this means, the United States’ immense capital cost advantage against emerging markets has been eroded. Since the superiority of U.S. educational institutions is for the most part questionable at best, there is now little to prevent U.S. living standards being driven inexorably down towards those of China or India. Just as baby boomers may face the problem of a penurious old age thanks to Bernanke’s policies, younger Americans may face diminished earning ability or high unemployment or very probably both. Both the “stickiness” of wages on the downside and the ham-fisted and expensive attempts by politicians to solve the problem are likely to make the inevitable decline in living standards even worse than it needs to be.
There is, however, a further problem of Bernankeism for younger Americans, which is only just heaving into view. The Federal Reserve Bank of New York recently produced a study of the student loan market, which showed that total loans outstanding were nearing $1 trillion, having more than doubled since 2005, and that the delinquency rate on those loans had risen above 10%. There are policies other than Bernanke’s that have caused this sudden explosion of debt. In particular, the 2005 Bankruptcy Act took the extraordinary step of making it impossible to extinguish student loans in bankruptcy, thus making student loans much more attractive bank assets than other consumer debt. The decision by government to guarantee a much higher proportion of student loans, thus removing their risk from banks, was also important. However, the crucial factor in their expansion was the Fed’s sloppy interest-rate policies, which made it ultra-attractive to banks to expand their balance sheets with student lending, knowing that even though there would be many defaults, the government would bail them out.
It is now becoming clear that the vaunted improvement in living standards caused by a college degree was largely the result of a booming economy and the generally superior cognitive abilities of those attending college. In the long downturn, with labor readily available, only those college graduates with specific skills have found their services in demand, and many who have spent $100,000 or more on their educations have found themselves waiting tables or worse. The hopelessness of many student loan problems is illustrated by the $180-odd billion of student debt owed by people of 40-49, with an average loan outstanding of close to $30,000 and a delinquency rate of close to 15% and rising. For those people, student debt is not a rite of passage of early adulthood, to be worked off as earnings rise with experience; it is a permanent millstone that will merge seamlessly into their pathetic attempts to save adequately for retirement.
The benefits of Bernanke’s short-termism have long since worn off; four years after the financial crisis, the long run has arrived. However, its costs will be with the vast majority of Americans throughout their lives, in excessive student loans in early adulthood, in unemployment and earnings suppressed by emerging-market competition against a decapitalized United States, in savings that can never keep up with inflation and in retirements subsisting on a diet of cat food. Truly the man has a lot to answer for.
