Known Unknowns


Welcome to Known Unknowns, a newsletter arguing that in the long run, incentives are important.

Let’s talk about debt

First the good news; Congress agreed on a stimulus bill. The country needs it. We can disagree if it should be bigger or smaller, but it is better than nothing. We are lucky we can spend like this when we need to. It's a privilege to borrow at such a low rate when the world is in a dark and uncertain place. The fiscal space we have made it possible to save lives and livelihoods. Can we count on that the next time?

Publications such as The Atlantic Monthly and The Washington Post, have hailed the arrival of a new regime, where we should run up debt all the time—during good times, bad times, just all the time. Because apparently the economist profession as a whole (or the credible economists, anyway) have decided that interest rates won’t ever go up, and neither will inflation.

This may be a reasonable view for the next year, or even the next 10 years. But the obligations that we’re making will take decades to pay off, and are these people willing to put money on what the economy will look like 30 or 50 years from now? If so, I have a 50-year swap to sell them.

The truth is that we have no idea what the world will look like decades from now. But even so, we’re making a spectacular bet that interest rates and inflation will stay low for at least the next 50 years. We’re running up huge debts and financing them with short-term bills. Or if you want to really get to the truth of it, we’re financing these debts with liquid bank reserves, because the Fed is the one actually buying most of this debt.

A few weeks ago in City Journal I asked the question, “What is debt?” You might say that debt refers to whatever we spend that isn’t covered by revenue. But I think that it’s any financial obligation. In theory, any service is a debt, too—the promise to educate your child, library hours, etc. But those services will be cut before we haircut bonds. A pension promise is certainly a form debt—in fact, it’s senior to a treasury bill. Well, maybe not legally, but politically pensioners are always paid first, so it seems to me that our debt estimates aren’t even close to being complete. If we included pension and healthcare obligations, then it’s much worse than it looks.

So, you might ask, “Why are bond prices still so high? Doesn’t that show that we’re in a new regime? Bond buyers aren’t stupid—they know about Social Security and Medicare, too.”

But here’s the thing: you can’t have it both ways. You can’t say that the market is showing us that there’s no risk because bond prices are still so high, but also think it’s fine for the Fed to buy so many bonds, along with financial firms who have to hold onto lots of debt for regulatory reasons.

If there was not so much at stake, it would be almost funny that, yet again, so many people think they’ve found new, clever reason why taking on tons and tons of leverage isn’t so risky after all.

Things work until they don’t. Markets aren’t what they used to be, but they can always change again. And if there’s one universal truth, it’s that once you count out a risk, it manages to reappear. Leverage is always extra risky.

Actually there's another universal truth, discretion is always dynamically inconsistent. I don't care if you call it forward guidance..but that's for another newsletter.

New DOL rule

Do you remember a few years ago when everyone was upset about fiduciary rule? This was legislation from the Obama years which required people giving financial advice to act in their clients’ best interests, which Trump’s DOL quickly nixed. People freaked out, but then promptly forgot about it, because they found something else to freak out about.

I’ve never been a big fan of the idea. Of course I think that anyone who gives financial advice should act in their customers’ best interests, but I don’t think you can legislate that without creating the right incentives.

What exactly are customers’ best interests? Is it not losing money on your investments, or holding onto a stable, predictable income after retirement? In fact, these are two different financial strategies that are sometimes at odds with each other. The DOL wagging its finger and saying that you better do right by people or you’ll be sued, without saying what doing right really means, will destroy any incentives for innovation in the retirement planning industry—and it’s an industry that really needs innovation right now. Many people need advice, and yet simply can’t afford it. And we still haven’t figured out how to manage assets in a DC world.

Anyhow, the DOL quietly published a new rule last week, which is an improvement on the old legislation—it’s more flexible, requires better disclosures of conflicts, and takes a small step toward actually defining what good advice really is. But isn’t it better to just align incentives and move to a fee-only model, and let financial advisors and brokers work out what’s in their customers’ best interests based on actually knowing their customers and their unique needs?

New York’s war on small business

Last week, New York continued its assault on the small business community. I’m not a public health expert, so I can’t speak to the wisdom of these new shutdowns. But is it really necessary to add more costs to small business owners on top of everything that they’ve already suffered? In just one week, New York has increased its minimum wage, made it harder for fast food franchises (often owned by small business owners) to fire employees, and is making Uber (and presumable all gig platforms) hire workers as employees, rather than contractors. All of this makes labor more expensive, and gig work is often how people supplement depressed earnings when they are out of work.

I feel like I’m trapped in a bad version of Atlas Shrugged (and it was not a good book).

Until next time, Pension Geeks! See you in the New Year!