THE BEAR'S
LAIR Bernankeism costs laid
bare By Martin Hutchinson
Two reports released last week began to
make clear the staggering costs to the US economy
of Federal Reserve chairman Ben Bernanke's
zero-interest-rate policies.
The first,
from Standard & Poor's, outlined the yawning
funding gulfs in US private-sector pension
schemes. The second, from the New York Federal
Reserve, 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 US$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 past 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 present 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 US 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 US 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 US$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 US economy. By
this means, the United States' immense capital
cost advantage against emerging markets has been
eroded. Since the superiority of US educational
institutions is for the most part questionable at
best, there is now little to prevent US 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 New York Fed 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 aged 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.
Martin
Hutchinson is the author of Great
Conservatives (Academica Press, 2005) - details
can be found on the website
www.greatconservatives.com - and co-author with
Professor Kevin Dowd of Alchemists of Loss
(Wiley, 2010). Both are now available on
Amazon.com, Great Conservatives only in a
Kindle edition, Alchemists of Loss in both
Kindle and print editions.
(Republished
with permission from PrudentBear.com.
Copyright 2005-12 David W Tice &
Associates.)
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