Allison's Ode to the Second Moment


Welcome to the 54th issue of Allison’s Ode to the Second Moment, a newsletter that indulges my need to obsess about bond risk premia.

The State of Retirement Finances Is Okay

Each week brings another story about the desperate state of retirement in America. This weekend, I added my contribution. I am more hopeful than most because the state of retirement is complicated. I consider a financially successful retirement one where a retiree can meet his expenses and has predictable income similar to what he had while working. A simple estimate of financial savings does not give the whole story because it does not include Social Security and other pensions.

And even if retirees don’t have enough, they probably have more, on average, than Americans had in the halcyon Defined Benefit days. So, let’s stop pining for a past that will never come back and was not so great anyway.

I do have some concerns. The shift from DB to DC saddled individuals with a very difficult risk problem that they are ill-equipped to deal with. We have been so focused on the headline saving numbers that we have not dealt with this huge issue. It feels like people think diversification and some halfhearted strategies to avoid large market losses in a single day are all that savers need. But they need more; they need help managing income risk and creating a spending plan.

While we are on this subject, Andrew Biggs does not think state-sponsored retirement accounts are a good idea. I think we should do more to expand coverage. Increasing access to retirement accounts will increase saving, and that is, most of the time, a good thing. And I never liked tying benefits to employers, just on principle.

I am pretty excited about the new bill making its way through Congress. It does many of the right things, such as making retirement plans more cost-effective for small employers, encouraging annuities, and providing more liquid emergency savings options. I am a fan, and I hope it passes in its current form.

Cash is the new avocado toast

A new survey from reveals that one in three Millennials think cash is the best investment for the long term. It seems they fear losing money because they were scarred by the financial crisis. That was also true for many children of the Depression.

But their fear of markets is a problem because their savings will be eroded by inflation and Millennials are missing out on higher returns. Bankrate’s chief finical analyst, Greg McBride, points out these youngsters are misguided:

Cash is entirely appropriate for your emergency fund,” McBride said. “But when saving for a decade or more, you can afford some short-term risk in exchange for the power of compounding the higher rates of return that come with investments like the stock market.

Sounds like the fallacy of diversification to me. If Millennials fear losing money so much, maybe they should stay away from risky assets, long or short term. There is no shame in risk aversion. In many ways, I like these Millennials’ investing habits. They like risk-free assets and don’t overleverage to invest in housing. Maybe we should give them a break.

Or, maybe risk aversion is the new luxury good. People criticize Millennials for throwing their money away on avocado toast, maybe their fear of the odd bear market is equally indulgent and short-sited.

Puerto Rican Bonds

It feels like we could talk about bond yields forever and never run out of things to say, such as what is up (or really down) with the term premium? Did QE work? Can we isolate and price inflation risk? So many pressing questions….

Here’s another: why were Puerto Rican bonds so expensive, even though they had a HUGE risk of default? A paper presented at Brookings argues it was because bond investors expected a bailout. Turns out they were wrong, and they got an inkling of that when Detroit did not get a bailout. After Detroit filed for bankruptcy, the risk premium on Puerto Rican bonds increased more than 400 basis points.

That, however, still seems low to me. Think about it; in 1989, the three-month Treasury yield was more than 8.5%. On the verge of bankruptcy, Puerto Rican bonds did not pay much more.

I know we live in a low risk-free rate world. But, gee, people will take on lots of risk—for not much these days. Are they that desperate for yield or are they misspricing risk?

A Self-Serving Political Opinion

I think economics expertise means something. It is not just a matter of opinion; there are basic definitions, economic relationships, and studies based on data. I feel bad for Alexandria Ocasio-Cortez. No one should be thrust into the spotlight as the future of their party at age 28. Sure, she is saying some weird things about the economy but all politicians do that. They should all get so much scrutiny and then educate themselves on basic economic principles before pondering industrial policy or offering large, unfunded entitlements—or at least hire or talk to experts.

But, is she any worse than Senator Heitkamp? Pension geek, Josh Rauh, testified before Congress last week, and Senator Heitkamp announced she did not want to listen to Josh, or the other experts on the panel, because they were not the ones losing their pension. That may be true, though they are taxpayers. And isn't it important to hear from experts about what is the best, sustainable solution, rather than just hear sad stories about the people affected?

Are We Ready for Another Crisis?

No, of course not; we never are. That’s what makes a crisis a crisis.

Laurence Ball’s new book on the last crisis should worry you. He explains how critical the Fed’s lender of last resort role is in keeping a financial setback from going nuclear. He worries Dodd-Frank made it harder for the Fed to play that role.

Meanwhile, John Cochrane worries that banks in the private sector won’t help out either. Bank of America and JP Morgan never got any love for taking on the liabilities of the troubled banks they bought. They even got saddled with billions of dollars of fines for things that went on before they owned the banks. Why would anyone buy a systemically important financial institution on the brink of collapse after that?

In Other News

A quick programing note: I will take the next few weeks off, summer/August/book edits, and will be back before you know it.

Until then, Pension Geeks!