Allison's ode to second moment: Eleventh issue
Welcome to the eleventh issue of Allison’s Ode to the Second Moment, a newsletter that explains how risk undermines our best-laid plans.
And we’re just getting started…
Several universities, Yale, MIT, NYU, Columbia and Duke, have been hit with lawsuits over their 403(b) and 401(k) plans. The lawsuit claims the plans charged excessive fees, offered annuities (where you can’t take money out!), and offered too many investment options (defined as more than 15). All of which, the lawyers allege, violates the sponsor’s fiduciary standard.
The Duke lawsuit is interesting, because it claims too many investment choices drove up fees and inflicted “decision paralysis” on plan participants. Sponsors can’t win. Offer too few choices, and you are more liable for offering a fund that doesn’t perform well in all markets; offer too many, and subject participants to indecision.
Look, I am all about well-curated, low-cost investment options—but does offering too many funds really violate the fiduciary standard? These lawsuits are exactly why I am skeptical that the fiduciary standard is a panacea for the DC market.
It does not seem like a good way to align incentives because we still have a fuzzy (or no) definition of what best interest means. It seems the lawyers decided best interest involves offering just a few low cost funds. People with even an elementary understanding of retirement finance know it’s more complicated than that.
Take longevity risk. Sometimes people need/want risk protection (say a deferred annuity), and paying others to take on your risk costs money. It pains me to see annuity become a dirty word. In this environment, what sane plan sponsor would offer one?
And where did 15 come from?
There is some merit to these lawsuits; many DC participants do pay too much in fees. But the more lawsuits we have over such vague standards, the worse it will be for consumers. A plan sponsor’s objective will become avoiding lawsuits rather than solving a problem that requires innovative, low-cost solutions. Expect sponsors to hire even more consultants to spread the fiduciary risk around. And you know what that means—more fees passed on to employees.
The right model at the wrong time
I long to live in a world where we can have balanced, thoughtful discussions on economic policy. Where we weigh costs and benefits and take time to identify the winners and losers. Sadly, even when we discuss arcane topics like monetary policy, it never happens. It feels like an act of political solidarity to insist low interest rates will fix all our problems by boosting demand.
It shouldn’t be that way. You can like an economic model—but that doesn’t mean it works all the time and will solve every problem. You wouldn’t use a screwdriver to hammer a nail, but that doesn’t mean you don’t believe in screwdrivers and hate poor people.
Perhaps low rates aren’t the right tool to fix our current economy. Interest rates have been low for 8 years, and the economy still feels weak. Now some central banks are going even lower, negative and further out on the curve. Savers have had enough. They are hoarding cash or not spending.
Maybe cutting rates from 8 to 7% results in different behavior than cutting rates from 0.5% to -0.5%. Maybe, if you have an older population, the wealth effect dominates the substitution effect. In that case, low rates result in less consumption and demand. Low rates may also reduce investment if firms must put more money aside to finance their pension obligations. How people and institutions respond to risk matters. But the aggregate-demand models we use to justify low rates assume a deterministic world. We know better.
This week, San Francisco Fed President, John C. Williams, acknowledged the challenges central banks face these days. One possible solution is changing the Fed’s targets—NGDP or higher inflation. But, before we further risk Fed credibility, maybe we should ask ourselves—if low rates can’t achieve the current inflation target, how will they reach a new, more ambitious one? I don’t know about you, but I am feeling forward-guidance fatigue.
Let them eat municipal bonds
A smaller share of Americans own municipal bonds. In 1989, 4.6% of Americans owned muni bonds, in 2013 only 2.4% did. And Americans who do own muni bonds tend to be super-rich. There’s concern that, if muni bonds become the asset class of the rich and hedge funds, there will be less sympathy for creditors when municipalities face bankruptcy (like we saw in Puerto Rico). Taken to the extreme, it may be hard to justify their tax-exempt status.
Perhaps, but I wonder if these figures understate the municipal bond exposure average people have through bond funds in 401(k) plans or their defined benefit plans. Still, it’s an argument worth considering, because these kinds of subtitles are often lost when the money runs out.
Speaking of regressive. How has forgiving MBA debt become a serious policy discussion?
Why are people so unhappy?
There’s one election prediction I can make with full confidence: for many years to come, 2016 will be the subject of many Political Science dissertations. Perhaps they’ll make sense of what’s going on, because we sure can’t.
The initial explanation, that Trump voters are economically disaffected, isn’t holding up, because many of them have jobs and decent earnings. Not to mention most Americans have never lived so well in terms of longevity, leisure and consumption. If things aren’t so bad, why are people so disaffected?
Derek Thompson thinks people don’t care so much about absolute living standards—they care more about relative standards, which suggests income/wealth inequality is the problem. I am not sure I’ve seen much evidence to support that theory.
I reckon absolute standards do matter---a lot. But being a good life-cyclist, I’d argue it isn’t just current standards that matter. It’s being able to maintain them in the future. If you feel more risk, and it threatens to your quality of life, that’s almost just as bad as no improvement at all. We live in a more uncertain world and have a thinner financial cushion to protect us. Maybe that’s why people are disaffected, even if their material living standards have improved.
Who knows? I’ll leave it to future generations of political scientists to sort it out. I am going to my expensive gym.
Until next time, Pension Geeks.