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Rate Cuts Accelerated Blue Model Crisis

The Great Recession undermined the structural foundations of Western pension systems for two reasons: First, because it slowed growth, lowered revenue, and increased fiscal strains across the board, and second, because it forced central banks to dramatically cut interest rates, sharply reducing the bond yields that make up a substantial portion of pension portfolios. The Wall Street Journal reports:

Central bankers lowered interest rates to near zero or below to try to revive their gasping economies. In the process, though, they have put in jeopardy the pensions of more than 100 million government workers and retirees around the globe. […]

Managers handling trillions of dollars in government-run pension funds never expected rates to stay this low for so long. Now, the world is starved for the safe, profitable bonds that pension funds have long needed to survive. That has pulled down investment returns and made it difficult for funds to meet mounting obligations to workers and retirees who are drawing government pensions.

Because they have a low tolerance for risk, pension funds “have roughly 30 percent of their money in bonds,” according to the WSJ. When bonds paid 10 or 5 or even 3 percent annual returns, this was perfectly sustainable. But now U.S. Treasuries yield close to nothing when adjusted for inflation, putting more pressure on pension managers to engage in risky investments in order to reach the returns they need. This has hit Democratic-leaning state and local governments in the United States particularly hard: 

Weaker cities across California could face bankruptcy without help, said former San Jose Mayor Chuck Reed, who oversaw a pension overhaul there in 2012 and is backing the 2018 initiative that would shift onto workers any extra cost above the capped levels. “Something is broken,” he said. “The plans are all based on assumptions that have been overly optimistic.”

Central bankers had little choice but to depress interest rates to help growth recover in the wake of the financial crisis. But this era of zeroed-out rates will nonetheless be remembered as a great tradeoff, keeping the economy afloat in exchange for the accelerated dismantling of the blue model pension and social insurance systems that we have taken for granted for decades.

This story highlights a broader point: Many of the fiscal and monetary assumptions that the West has relied on since World War II are being called into question by globalization, technology, and demographic change. The managerial class needs to think outside the box to address this challenge, rather than doubling down on creaking institutions whose time has passed.

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  • Fat_Man

    A call for people to think outside the box is the least outside the box thing you can call for.

  • Jim__L

    “Central bankers had little choice but to depress interest rates to help growth recover in the wake of the financial crisis.”

    Er, no. They didn’t have to make any adjustments at all, and allowed unprofitable ventures to fail, instead of allowing them to live on as zombie business models.

    They could have allowed huge banks to unwind gracefully, firing their demonstrably incompetent C-levels and allowing fresh blood to reinvigorate the system.

    BUT, instead, they doubled-down on everything that didn’t work about the system.

    Central bankers have a lot to answer for.

    • f1b0nacc1

      Milton Friedman did a wonderful job of ennunciating this point in an episode of ‘Uncommon Knowledge’ he did on PBS back in 1999 (I think that was the year)…

  • JR

    The managerial class needs to think outside the box to address this challenge, rather than doubling down on creaking institutions whose time has passed.

    Is there a better one sentence summary of FG, this is it.

  • Wayne Lusvardi

    What makes American economy strong is its pluralism: a global economy, a local economy, regulated monopolies, free market economies, part socialism, part Ponzi scheme Cap and Trade, etc. The problem with a One-Size-Fits-All Globalist Economy is that it makes all other economies play by its rules.

    The Global Economy requires banks to divert capital to stocks and away from bonds and mortgages to finance global enterprises and prop up underfunded government pension funds that are invested in stocks. The problem is this creates asset bubbles in stocks and real estate and in the coupon price of bonds but near zero returns on bond and savings account interest. So the Working Class can’t afford the bubble inflated price of a home and can’t save enough money to afford a down payment on a home or college education for their children.

    Social engineers thus designed Sub Prime mortgage loans to make housing affordable that eventually brought down the whole economy and decimated the Working Class with foreclosures, bankruptcies, divorces and substance abuse.

    As a consequence the American theodicy (religious explanation of suffering or success) of hard work, saving, ingenuity and profit seeking was replaced with an ethic of consumption, gaming economic bubbles and arbitraging (gambling). Flipping “spec” houses became a national industry.

    The problem with any economy that doesn’t use markets to price goods or investments and relies on political engineering of bubbles is that there are typically unintended social consequences, that far outweigh any benefit. What is the true value of a stock that is inflated way, way beyond any realistic price/earnings ratio of profitability? Without the price discovery of markets no one really knows except to enjoy the inflated prices of stocks and real estate at everyone else’s expense. Even Karl Marx once explained that the only way out of a depression was to restore profitability, or the measure of profitability to estimate value, to businesses and industry (see Michael Roberts, The Long Depression).

  • Anthony

    Modern capitalism has become a complex game, and those who win at it have to have more than a little smarts (including the “managerial class”). Moving money from the bottom of the pyramid to the top infers asymmetries of information as much as structural undermining.

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