Allison's Ode to the Second Moment


Welcome to the sixty-seventh issue of Allison’s Ode to the Second Moment, a newsletter that will warn you when the revolution comes.

Millennials declare war

One of the lasting legacies of the original New Deal was Social Security, or the creation of a major entitlement for the elderly. This marked the start of the government (and not just the U.S.) spending a significant amount of resources on the elderly. No judgement here, as redistributing resources to the elderly can be efficient if it’s structured well. Like it or not, that’s what remains of the New Deal, and as the size of elderly population has grown and benefits have been expanded, it takes up more of our budget.

What I found most interesting about the Green New Deal was that, in addition to the environmental proposals, it advocated for the creation of several major entitlements for the young. Free college, health care, and guaranteed jobs would all become the responsibility of the government. Now, I’m not going to comment on the merits of these programs. But they are remarkable because young people are demanding that we spend more on them. And, while these particular policies may not be the best way to do it, investing more in young people may be a smart thing. Does it really make sense to spend 40% of our tax revenue on the elderly, rather than investing in human capital for the young people entering the work force? I’m not sure it does.

The problem is that we only have so many resources available to spend. Contrary to the new public opinion, we can’t print trillions of dollars to pay for stuff. We’ve made promises to retirees that would be both difficult and inhumane to break. But if young people are demanding more, is it a leap to wonder whether they’ll eventually get fed up with their tax dollars supporting the elderly, and then make more muscular demands?

Will we look back on the Green New Deal as the first shot fired in the upcoming generational war?

The $78 trillion pension bomb

On a related note, the other economic discussion in the news is debt. Several prominent economists are bravely coming forward and saying that maybe rich countries can run deficits after all. In the fine print, they hedge on that position, stating that interest rates need to stay low, the money needs to be spent productively, etc. But most people aren’t interested in the fine print, and debt is here to stay, so we had better hope that low interest rates are, too.

Who am I to question Larry Summer’s fine judgment? But if we do decide that it’s good economics to run deficits most of the time, I advocate including pension obligations when we calculate debt.

After all, when it all goes down and a debt crisis occurs, pensioners are usually senior to everyone else, bond holders, and definitely tax payers who need services (or at least they are now, we’ll see how the revolution plays out). When we wonder if our debt level is sustainable, it only makes sense that we include the enormous obligations that will be paid first. In the U.S., I think that Social Security (all unfunded) obligations probably won’t cause a debt crisis. But what’s going on at the state and local level might. By some estimates, unfunded pensions are larger than all outstanding municipal debt.

It remains a big unknown whether or not the federal government will need to step in. Otherwise, certain states and municipalities, already facing outflows of young talent, will further diverge from the fortunes of rich coastal cities. And don’t count out Europe and Brazil, who have large unfunded pension obligations that are currently eating their budgets, as well as aging populations who are demanding more resources with fewer workers to pay for it. Citibank estimates that unfunded pension obligations are already nearly $78 trillion.

The pension question remains a big unknown. We don’t know whether pensions will cause a debt crisis or defaults. But they are a major risk that many debt doves don't account for.

Deficit spending is a powerful policy tool that can alleviate needless hardship during a recession, and the option to boost the economy this way is extremely valuable. The more debt that you have, the more expensive that option is. Pensions mean less fiscal space when you need to spend it. So, when we ponder the ideal fiscal policy, we should account for how much debt that we’ve really issued. That’s all I’m asking.

How’s that pension freedom working out for ya?

Once upon a time, British retirees had to buy an annuity. But between low interest rates and the fact that people just don’t like annuities, starting in 2015, they are now allowed to spend their retirement savings as they wish. This is called pension freedom.

The spending problem remains a big unknown in DC pensions. We’ve spent lots of time working out how people should save and invest, but then we leave them hanging on the hard part: spending. Annuities are one viable option, and they work pretty well, but people really hate them because they don’t like handing over their life savings to an insurance company. Pension freedoms offer a useful data point regarding what people will do without an annuity.

According to the Financial Times, people use their pension pots to pay off debts, renovate their homes, and help their children. Many pensioners want to be responsible, but they don’t know how to manage their money and don’t know how much they can spend (in all fairness, Bill Sharpe says that they are facing the most difficult financial problems that he can think of). British retirees are seeking help and paying too much for terrible advice. It turns out that the UK got rid of the annuity requirement, but did not institute regulations to protect retirees who are now left to fend for themselves.

In other news

  • Good thoughts on leveraged loans

  • The history of insurance

  • Systematic BBQ risk

  • The ever-patient Andrew Biggs on the retirement crisis that isn’t (assuming those pensions are paid)

  • Evidence suggests that the Fed doesn’t have much control over long-term interest rates, and this was true even under QE and Operation Twist. Maybe the Fed has some influence, but it can’t actually set the market price. And yet the idea that the Fed has a magic lever with which to control the entire bond market is at the core of many strange economic arguments these days.

Until next time, Pension Geeks!