Allison's Ode to the Second Moment


Welcome back, Pension Geeks! I hope all of you had a good August. This is the thirty-sixth issue of Allison’s Ode to the Second Moment, the newsletter on the risk that robots will take your job and other catastrophes.

End of lectures

For as long as people have labored, new technologies came along and changed the jobs people did and how they worked. Now is no different, and yet some jobs seem immune to this change, for example: teaching. For thousands of years, teaching has consisted of a learned person lecturing and asking questions to solicit the students’ responses. Teaching requires a teacher and cannot be outsourced to a machine—or so it seemed.

I never thought online learning would be a game changer. A college education is about so much more than classes. On campus, a large social component exists among students, along with mentoring by their professors and class discussions about provocative ideas. Earning an online degree cannot match the on-campus interactions. At best, I figured that colleges would devolve into a two-tier system of in-person and online classes.

But the line between online and onsite is blurring. This fall, Jon Meer and Steve Wiggins at Texas A&M are offering their introduction to micro class (a requirement for several majors) online-only. Enrolled students, who live on campus, must view online content instead of attending classroom lectures. This is not just a video of Meer lecturing; instead, it is interactive content filmed for this class.

Big lectures were never a great way to teach. Students found them unengaging and attendance normally dropped during the semester. It does seem more efficient to move large lectures online and free up resources for smaller in-person seminars. For large public universities like A&M, moving lectures online could mean more students get a small liberal-arts-style education. What’s happening at A&M offers an interesting parable about how technology can disrupt one thing and offer something better in return.

Parents at A&M are skeptical. Who wants to pay tens of thousands of dollars for online lectures? And aren’t we already worried that members of iGen never leave their rooms and live their lives online; and now they don’t even need to go to class?

As socialization remains a big part of the college experience, maybe something will be lost with more online lectures, even if it is a better way to learn. Over the next few weeks, I will have more stories on how technology is radically changing the college education.

Who pays for all the hurricanes?

The wave of terrible storms has caused so much damage, we don’t even know yet how much rebuilding will cost. News reports suggest many people don’t have hurricane insurance, but many others do, and this will mean large payouts from insurers. I hope their risk models accounted for two once-in-a-lifetime storms in the same month.

Even if their models did, many insurers sold catastrophe bonds to hedge some of their risk. With these bonds, insurers pay another party coupons. Then if a catastrophe happens, bondholders risk losing their principal to the insurer.

You can guess what happened to the price of these bonds this week. Many were trading 50 to 60 cents on the dollar. Bondholders figured they’d take the known loss on their principal by selling their bonds cheap.

All that risk and so little reward. According to the FT the yields on catastrophe bonds have fallen recently, which sounds crazy. It seems like a catastrophic storm has become an annual event and, with global warming, it could get even worse. Why would anyone accept such a low yield to cover such an expensive tail risk? It isn’t even a tail risk anymore.

Well, that’s the low rate environment for you.

Enough with the passive hysteria

Judging from the tenor of the commentary on passive investing, you’d think passive funds have taken over markets. They are certainly getting more popular, right now index funds make up 17% of mutual fund assets, up from 4% just 20 years ago.

But it is still 17%. I don’t think we have to worry that firms aren’t accountable to capitalism anymore or are colluding with their competition. For these things to happen, indexing would need to be a much bigger share of the market.

Besides, even if most retail investors went passive, active management isn’t going anywhere. A large share of investable assets will always be in active management because institutional investors will never go all in for index funds. Institutional managers need to justify their jobs, which involves finding managers who will deliver alpha. Pension funds need to justify their crazy discount rates, which passive investing will never deliver. Then, sometimes there are just institutional constraints that limit adequate diversification through passive funds.

I think everyone can relax. Active managers will still have jobs, if they can resist the robots, and capitalism will continue to function.

The case for 401(k)s

The current political administration keeps reassuring us that the tax-treatment of retirement accounts won’t change. However, there is a persistent rumor that this is an empty promise and tax reform will include making contributions to 401(k) and IRA accounts taxable.

This may sound like a good idea. After all, it’s more revenue today, and there’s evidence it won’t change saving. But the problem with the budget projections that tout more revenue, is they only go out 10 years. We may get more revenue today, but there’s less in the future because no taxes are collected on withdrawals after retirement.

There’s another good reason to keep the tax-deferral on retirement accounts. That deferral gives the government a way to encourage people to annuitize their retirement savings or take phased withdrawals.

If the money in these accounts aren’t subject to taxes, the government can't discourage retirees from blowing all their savings on boats. The saving phase is only one small part of the retirement problem. How people spend their money one day is just as important and a harder risk problem. Why give up our main tool to nudge people toward better decisions?

Oh, and several people on social media complained that retirement accounts are regressive. I am not so sure; and not only because of the contribution limits. A major benefit from retirement accounts has been a bigger, more diverse stock-owning population. The distributional consequences of messing with 401(k)s isn’t so obvious.

Until next time, Pension Geeks!