Helicopter Fed

Helicopter monetary policy is taking on a new meaning

Photo by Luke Stackpoole on Unsplash

Hello,

Welcome to Known Unknowns, a newsletter that was not the beneficiary of nepotism but won’t judge if you were.

Getting rid of risk is the biggest risk

I have an essay in Bloomberg Markets about our inclination to remove risk from the economy. It seems like every time something bad happens in the economy we decide we need policies to keep it from ever happening again. And sometimes that is wise, say if a bad recession or stock market crash reveals some crazy distortion or externality that needs to be eliminated. But often, we tend to try to eliminate any bad thing. Take the great financial crisis. At the time, I heard a lot of, “This just shows an economy based on risk is not worth it.”

And I think it was easy to believe that because it coincided with the rise of the Chinese economy that seems to achieve a high-growth, no-risk model. I also heard a lot of, “It is clearly a better model,” with their industrial policy and ability to move capital around to favored industries. They have “6%” growth every year. Or they did. Meanwhile the west experienced a long slow recovery.

But growth, or sustainable growth, and risk go together. And if you try to remove risk, you either get stagnation or, more likely, huge distortions that cause even more trouble, as we see in China right now. We’ve seen this before; when your economy is playing catch up it is easy to grow, whether you have an industrial policy or not. But sustaining growth requires innovation, and that does not happen without risk. And China has not proven it can innovate, and with all the distortions it’s created in an attempt to avoid any downturn or loss of control, it faces some big challenges ahead.

Though that’s not the lesson we decided to learn. After the financial crisis, the lesson seemed to be we can eliminate downside risk too if we just go big enough. A narrative emerged that we went too small last time (debatable), and there is no limit on how big you should go to make economic pain go away. The government started acting like a helicopter parent, and we spent a crazy amount of money during the pandemic. Some of the spending was necessary. But policymakers not only wanted to avoid any economic pain, but they also aimed to give everyone a check for their trouble too. Now we have inflation.

And in Bloomberg last week, I wrote about how Fed policy contributed to a very screwy housing market. Remember when there were bidding wars in Boise and 30-year fixed-rate mortgages were 2.5%? Well, at that point, the Fed was buying pretty much every mortgage-backed security (at a faster pace than they during the GFC). It could not defend why it was pouring pure propane on a market that was already on fire. But the thinking at the time was to go big so no one suffers any loss, without any thought of potential costs.

But, eventually, QE (still not sure if it does anything useful) stopped and mortgage rates went back up. Now, the market is weird—sales down, prices up, and frozen in some places. And I think it will be screwy for a while because no one who got a cheap mortgage can afford to move. And the MBS market will be weird because no one will refinance either, so the duration of these securities is totally unpredictable.

Market interference is never a free lunch. Some markets are just risky, and there is no way to avoid it. True, the housing market is already weird because there is so much interference. The federal government subsidizes demand by creating very cheap 30-year fixed-rate mortgages (that don’t really exist anywhere else, and honestly, if individuals are paying 0% interest (after inflation) on loans for 30 years—something is really off risk-wise), while local governments limit demand through zoning restrictions. No wonder prices are so high. What do real estate prices mean anyway? But still, the Fed buying the entire MBS market in the middle of a housing boom?! That’s crazy, and it did not eliminate risk—it only created more.

Nudging is overrated

Saving and investing for retirement is hard. There are many risks; how long you’ll live, how much money you’ll make, and what will happen to markets are all unknown. And just when we think we’ve figured it out, there is another curve ball. In the mid-2000s, economists (but not pension-geek economists) and policymakers got very excited about nudging. Apparently, the thinking went, the problem with DC pensions is that people don’t know what to do with them. They don’t know how much to save or how to invest. So, if we just do it for them and offer the option of opting out, all will be well.

Now, we have 15 years of data on how it went. It turns out nudging does not do much to increase saving. People save what they want; they aren’t so passive when you take money out of their paychecks. But nudging did have a big impact on investing. Before nudging, people kept their portfolio allocations pretty constant as they aged or kept their money in cash. But automatically enrolling people in target date funds (TDFs) means more people now own stock and move into bonds as they age.

Great. But the problem with TDFs is they don’t help people spend in retirement, and that is the whole point. And while I agree people should move into bonds as they age—because of lifecycle finance, not because a shorter time in markets is riskier—TDFs move people into the wrong kind of bonds. They are mostly in short-duration bonds (less than five years), while the duration of your future spending at retirement is more like 12 years. This leaves people exposed to interest rate, market, and inflation risks.

Nudging is not enough; you need good defaults too. And in a changing-rate, high-inflation environment, we’ll start to see the costs of TDFs’ shortcomings.

Oh, and don’t say this shows DB plans are better.

Nepotism is underrated

I wrote a longish essay in defense of nepotism, or, as I like to call it, an efficient and early transfer of human capital. Seriously. I meet a lot of people who do some unusual jobs: Sex workers, bounty hunters, mob hitmen, horse inseminators, pensions actuaries—you name it. And the first thing I always ask them is how they got into this line of work. And nine times out of 10, I hear, “My father.”

There is something to that. Nepotism is about more than getting an in at our first job. Our parents expose us to ideas and skills early; they can act as coaches and mentors when they know our business. And they bestow a sense of pride on our work, which is lacking these days.

And, surprisingly, nepotism is most common in manufacturing and many blue-collar jobs. It is not just for movie stars and politicians. Nepotism is only bad when there is a finite number of good jobs, which there needn’t be. The economy is not zero-sum, and we can find ways to spread the human capital around to people not born into certain families.

I even managed to call Larry Summers a nepo-baby, though I meant it in the best way.

Until next time, Pension Geeks!

Allison