Monday, March 17, 2008

Who gets crammed

Daniel Gross has long advanced the argument that this decade will be the cram-down decade in which explicit and implicit promises to most people will be routinely broken as more has been promised than is available to fulfill those promises. Furthermore, the incentive structure is set up to discourage the fulfillment of those promises in the quest for short term returns.

Healthcare, defined benefit pensions, and pay raises in line with productivty increases, are some of the explicit promises being broken. The substitution of defined contribution plans (think 401(K) or 403(b)) has the implicit promise that people can still decently retire on their savings but due to a combination of systemic risk, low/no real income growth, inflation ex inflation and behavioral reasons as to why individuals are poor investors on their own, this promise is weak.

Paul Krugman in today's New York Times notes that the Federal Reserve will be attempting to engineer a series of bail-outs for the credit/insolvency crisis. Hopefully this bail out is a systemic bail-out and not a get out of jail free card for people who have made dumb decisions. It should be targetted at people who made good decisions using good processes but got kicked in the nuts anyways. I don't think we'll see that type of bailout this year; I don't think we'll see a formal bail-out at all this year.

Dave at the Glittering Eye is making a very smart prediction on some of the policy and political dilemnas facing any potential bail-out.

BTW, a lot of the shareholders and bondholders he’s saying should take a bath are institutional investors, particularly pension funds. As I’ve been saying for nearly 30 years the scandal of the 2010’s will be the default of pension funds.

I agree with Dave that a lot of the large institutional pension funds are in trouble due to systemic risk --- the value of their assets falling sharply just as cash outflow increases as my parents' generation retires. However I am also placing a high degree of trust in retiree's political self-interest in guaranteeing that the promises that had been made to them either implicitly or explicitly will be honored, or at least dishonored the least. Gray power is real, and with Boomers entering into the highest propensity to vote years as a massive cohort, they will continue to get protection at the expense of everyone else. And that means a tougher job market as fewer Boomers drop out to retire, higher taxes to insure Social Security is more generous and in the intermediate term solvent, and large general revenue transfers to both the Pension Benefit Guarantee Corporation and some type of super special add-on to the 401(K) that has yet to be created.

The Boomers won't take getting crammed down if they can avoid it, and they are numerous enough to avoid the worst of the pain.

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