Allison's ode to the second moment


Welcome to the 30th issue of Allison’s Ode to the Second Moment, a newsletter that reassures you, even if markets crash and municipalities go bankrupt, we've still got the little things that matter: good hygiene and long duration.

Where’s the risk?

If you watch the news, it seems like the world has gone crazy. There’s so much burning outrage and even more fuel poured on that burning rage. I am becoming more desensitized to the news, and am not alone. It appears the markets are shrugging political reports the world is in a meltdown. The VIX, the market risk gauge, is at its lowest level since 1993. How can it be so low?

There are many possible reasons. It could be traders are piling on with their bets against volatility and there’s just a bubble due to pop with a nasty correction. I’ve even heard people blame index funds. They’re a bigger presence in financial markets and the markets are acting weird. You can’t deny the correlation—even if there’s no compelling theory of causation.

Matt Levine points out something else I’ve observed. There appears to be a market consensus that we are in a low-risk environment. But pretty much everyone you speak to who works in finance, granted this is anecdotal evidence, is convinced the tsunami is coming any day now. Several traders and strategists solemnly told me they are all in cash.

Meanwhile, public pension funds are loading up on alternative (riskier) investments. If public markets do crash, those pension managers can say they dodged a bullet. They can report pretty much any return they want on their alternative portfolios. All will be well, until they actually need the money to pay benefits.

Long bonds

In the spirit of assuming we are in for a long, stable, low-rate future, let’s talk about long bonds. Secretary Mnuchin once again suggested the Treasury issue the longer-term bonds (beyond 30 years). Some people think this is crazy, after all, long-term debt offers so little yield. Who would want such a thing? What if the Treasury holds an auction and no one comes?

I am less fearful. Some of us just can’t get enough duration, bring it on! If the whole world goes to hell, at least we can hedge our long-term liabilities (assuming the government doesn’t default).

Why we all need duration more than ever before

There is a very exciting new paper out that takes Social Security earnings histories and estimates lifetime income. Pretty much everything you read about stagnating income and inequality is a little wrong because they are based on a snapshot in time.

For example, when people say Americans don’t get raises any more, that is not technically true. Individuals’ earnings still go up most years as people age and gain more skills. The median earnings of the whole country is what’s stagnant. Don’t get me wrong, that is bad because stagnating median income means stagnating national prosperity. But the fact is, most American households still get raises most years.

Measuring people’s lifetime income is also necessary to untangle what’s going on with widening income inequality. Suppose older people get paid more than younger people because the former group got bigger raises than previous generations. That could happen if the labor market now rewards skills and experience more. If that were true, you’d see more inequality between the young and old. If young people also get those raises one day, then it’s not clear there’s a big divergence in welfare

But alas, that’s not what happened. The paper shows Americans still get the same raises. But starting salaries for people at age 25 fell. And it turns out most pay increases happen by the time people turn 35. Income among 25-year-olds is also more unequal. The paper speculates what is happening to 25-year-olds is at the root of rising inequality and stagnating average income.

If it’s any consolation, everyone has way more more stuff than ever before, and I don’t just mean iPhones. Our everyday necessities were once exotic. For instance, in 1966, only 5% of German men changed their underwear every day.

We also have more and better leisure time. We have longer retirements in better health. Here is the interesting history of the 65 retirement age. We still have an industrial era attachment to this idea, which is totally out of date because most people living longer. In many ways, retiring at 65 is a relic of the past. The normal Social Security retirement age has already increased and lots of people in Europe and Brazil retire even younger

Government’s quest to undermine retirement security

Given lower incomes and longer lives sounds like we need to save more. Last year, several states began to offer retirement accounts to people who didn’t have one through their work. Congress just repealed a rule that exempted these accounts from ERISA. Subjecting the accounts to ERISA standards makes them much more expensive and difficult for states to administer.

Now, it may be because I think the fiduciary standard is over-rated, so I don’t love ERISA. I think Congress made a mistake. The justification is a fear the state plans will kill competition in the private sector. I guess, but given the high fees on small plans and lack of coverage, is this really a competitive industry that it requires preservation?

Oh, and speaking of rolling back helpful legislation, Bernie Sanders, Tammy Baldwin, and Al Franken proposed a bill that will take away Central States’s authority to reduce defined benefit pensions. I appreciate the sentiment. No one is more sympathetic than a retired teamster facing a pension cut. But the money is just not there. What else can we do?

Hard truths about insurance

Speaking of the expensive benefits we need to pay for, Tyler Cowen has an interesting column on what we don’t want to admit about health care:

It costs a lot and someone has to pay for it.

Truer words were never spoken. I agree maintaining the right to buy insurance with a pre-existing condition is important. But if you allow people to forgo insurance until they get sick, that makes insurance very expensive for everyone and there’s no good way to get around it.

Yes, I’ve seen polls that more Americans than ever want single payer insurance. But the question, “Do you think the U.S. should have single-payer health care system?” is meaningless. A better polling question is, “Are you willing to give up your current health insurance for government-run insurance that involves narrower networks and rationing of care?”

Puerto Rico

On that cheerful note, did you see Puerto Rico is heading toward declaring bankruptcy? This is actually good news because it needs debt relief. Bankruptcy will surely lead to a showdown between pensions and bondholders. When money runs out, they are always the last ones standing and fighting for whatever money the commonwealth has left.

There is so much going on, Puerto Rico’s problems aren’t getting enough attention. That’s too bad. Puerto Ricans need more than bankruptcy; they need a viable path for growth.

Until next time, Pension Geeks!