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It costs a lot more to fund a modern retirement. Employers, workers and governments are not prepared
EMPEROR AUGUSTUS came to power with the help of a private army. So he was understandably keen to ensure the loyalty of his soldiers to the Roman state. His bright idea was to offer a pension for those in the army who had served for 16 years (later 20), equivalent in cash or land to 12 times their annual salary. As Mary Beard, a classical historian, explains in her history of Rome, “SPQR”, the promise was enormously expensive. All told, military wages and pensions absorbed half of all Rome’s tax revenues.
The emperor would not be the last to underestimate the burden of providing retirement benefits. Around the world a funding crisis for pension schemes is coming to the boil. Rahm Emanuel, Chicago’s mayor, is struggling to rescue the city’s pension plans; the municipal scheme is scheduled to run out of money within ten years. In Britain the pension problems of BHS scuppered attempts to save the high-street retailer; the same issue is complicating a rescue of Tata Steel’s British operations.
The roots of the predicament lie in defined-benefit (DB) pensions, which guarantee a pension linked to workers’ salaries. These may provide security for the retired but have been expensive for employers. In many cases, DB pensions were offered decades ago when they seemed like a cheap alternative to awarding pay rises. Private-sector employers now usually offer new workers defined contribution (DC) schemes, which hand them a pot of money on retirement with no promise of the income it will generate. In time, this will create its own huge problems as workers face an impecunious retirement.
The DB problem is most obvious in Britain and America where many employers operate funded systems, in which contributions are put aside and invested to pay pensions. Many European countries operate on a pay-as-you-go basis, in which retirement incomes are paid out of current profits or taxes.
That does not mean the problems have disappeared; they are just harder to quantify. Citigroup reckons that, in 20 OECD countries, the unfunded government liability is around $78 trillion.
There are two reasons that funding pensions is becoming ever more troublesome. First, people are living longer. In 1960 the average American, British or Japanese 65-year-old man could expect to live for another 11-13 years. Women could look forward to 14-16 more birthdays. Now it is 18-19 years for men and 20-24 years for women.
Funding decent pensions is all the more difficult given that the proportion of retired workers is also growing. Around 600m people aged over 65 now make up around 8% of the world’s population; by 2050 there will be 1.6 billion, more than 15% of the total. Some countries face a bigger problem than others. In Japan, a third of the population will probably be over 65 by 2050; in Europe, the proportion will be more than a quarter.
Second, the low level of interest rates and bond yields means the cost of paying pensions has gone up, even without the longevity factor. Investors who have to buy their own pensions know this only too well. In the late 1990s, £100,000 ($164,000) would have bought a 65-year-old British man a lifelong income of £11,170 a year; now it will earn £4,960, according to Moneyfacts, a data firm. In other words, paying out a given level of income now costs more than twice as much as it did.
Government-bond yields in rich countries are at historically low levels; in some countries, they are even negative. This has a direct impact on pension deficits, by increasing the value of future pension liabilities. Because the cash cost of a pension will not fall due for decades, pension schemes must discount this cost at some rate to calculate how much they need to put aside now. If the cost next year will be $100, and the discount rate is 5%, then the cost in today’s terms is $95. The higher the discount rate, the lower the present cost.
For a long time, most company pension schemes used the assumed rate of return on their assets as the discount rate. The rationale was simple; a combination of contributions and investment returns will eventually pay the benefits. But this approach was prone to wishful thinking; if markets have performed well in the past, the temptation is to assume they will continue to do so. The higher the assumed future return, the less cash the company has to put aside today.
Actuaries and financial economists started to think more deeply about how to account for pension costs in the 1990s. Using investment returns is theoretically dubious. A company is required to pay pensions whether or not high investment returns are achieved. A pension promise is like a bond; a promise to pay a series of cashflows in future. That suggests the yield on long-term debt is the appropriate discount rate. In the early 2000s accounting regulations began to require companies to use a corporate-bond yield as the discount rate. Since the bond yield was much lower than the assumed investment return, the effect was to increase the stated level of pension liabilities.
Finance directors must feel like Sisyphus, doomed to push a rock uphill for eternity. In America, the estimated deficit of large firms at the end of last year was $570 billion, according to Mercer, a consultancy. The average funding level was 77%. In Britain publicly quoted companies in the FTSE 350 paid £75 billion into their schemes between 2010 and 2015, according to Mercer, but their collective deficit still grew by £34 billion over the same period.
Creating the PBGC and PPF has recast the problem of more expensive pensions in a different form. Regulators try to protect schemes by ensuring they are well-funded and that companies do not take advantage of the potential “moral hazard”—underfunding their plans because of the insurance protection. But make funding of the schemes too strict and firms will complain; some may even be forced to the wall.
So the temptation is to allow a lot of flexibility and hope that funding levels recover. BHS went into administration (the British equivalent of Chapter 11 bankruptcy protection) with a pension deficit of £571m. The company has been struggling for years; it had a recovery plan for its pension scheme that was scheduled to take 23 years. Should the regulator have allowed the company such latitude? The regulator is negotiating with the business’s previous owner, Sir Philip Green, about his making payments that will reduce the deficit. The saga has triggered a fierce debate about the moral and legal responsibility of business owners to ensure pension schemes are fully funded.
In America the PBGC depends on Congress to ensure it is properly resourced. As well as covering the pension plans sponsored by large firms, the PBGC backs schemes in industries with lots of small employers, such as mining and trucking. At the moment the PBGC estimates that it faces a potential liability of $52 billion on these multi-employer schemes over the next decade. The Central States pension fund, responsible for the benefits of 400,000 truck drivers and warehouse workers, recently said it would run out of money by 2025. But Congress has set a levy of just $27 for this type of employee per year; an annual sum of only $270m, ludicrously short of the amount needed.
The PPF is better funded than the PBGC. It has reserves of more than £3.6 billion before the impact of intervening at BHS’s fund (and possibly Tata Steel’s). Nevertheless, the fund has assets of £23 billion and the companies it covers have an aggregate funding deficit of £459 billion. Moreover, both insurance schemes face the long-term problem that they were established to back DB schemes, often set up many decades ago by manufacturing firms. As those types of companies die off, new services and technology firms are not joining the fund, because they do not offer DB pensions. The levy’s burden is falling on a dwindling number of companies.
Governments, which often offer their workers DB pensions, have been far slower than the corporate sector in attempting to reduce the cost. In large part this is because of the way they account for pensions. In America they are allowed to assume a return of 7.5-8% on their investments, making deficits look a lot smaller. But generous accounting assumptions do not make the problem go away. The Centre for Retirement Research (CRR) at Boston College has looked at around 4,000 American state and local-government pension plans. Even using the accounting standards permitted, the plans were on average 72% funded at the end of 2015. On a more conservative 4% discount rate, this drops to 45%. On the former basis, the collective deficit is $1.2 trillion; on the latter $4.1 trillion.
Difficulties are starting to emerge in America. Detroit’s bankruptcy in 2013 was in part the result of a huge shortfall in its pension fund; some retired workers suffered cuts to their income and health-care benefits. But the city still has a long-term pension problem, with a $195m payment to the plan due in 2024. Cities in better health than Detroit are also grappling with the pensions burden. In Texas, Fort Worth’s credit rating was reduced by Moody’s, a rating agency, in May in response to a $1.5 billion pension-fund shortfall.
The hole keeps getting bigger. Required public-sector employer contributions have nearly trebled as a proportion of payroll since 2001. But in practice, they have not been paid: since 2006, contributions have been regularly less than 90% of what is due. Closing the deficit will require higher taxes, or benefit cuts. But states and local governments are constrained by laws which say that benefits, once promised, cannot be reduced. Unless markets deliver implausibly high returns, more and more cities and states will be forced to juggle the interests of workers and taxpayers, with angry voices on both sides.
What is the answer? The Dutch have a robust pension system which is still linked to salaries.
The regulations demand that schemes are fully funded at all times; if funding falls below 105% of liabilities, then there is scope to reduce benefits.
Some American states and cities have likewise been able to reduce their pension costs by limiting the amount of inflation indexation that applies (of course, that will only work if there is some inflation).
In Arizona, voters approved in May a proposition that limited inflation increases for policemen and firefighters to 2% a year. But aping the Dutch model in America and Britain would require huge amounts of money to eliminate current pension deficits—money that employers may not have available.
The private-sector funding problem will, at least, diminish in the long run as old DB schemes run down. But there will be no respite for governments. They have been slow to switch workers to DC schemes, because the power of public-sector trade unions to resist lower benefits is greater than in much of the private sector. A two-tier system may emerge, with retired private-sector workers finding themselves worse off than their public-sector counterparts, but still funding those luckier workers through their taxes.
The essence of the problem is clear. Low rates mean that employers and workers need to put more money aside for retirement. Many are either not contributing enough or ignoring a problem that seems a distant threat. They would do well to remember that in Augustus’s time the Roman Empire looked invincible. But the troubles that overwhelmed it were already taking firm root.
Who’s the Systemic Risk Now?
Washington’s assault on Deutsche Bank imperils Europe’s economy.
Regulators like to bray about the dangers of systemic financial risk, but they seem not to care when they’re the source of the risk. Consider the U.S. assault on Deutsche Bank DB 3.19 % that has tanked European bank shares this week.
The German bank’s share price has fallen as much as 20% since a Sept. 15 Journal report that the U.S. Justice Department is seeking a fine of up to $14 billion for selling mortgage-backed securities between 2005 and 2007. That is well beyond Deutsche Bank’s ability to pay, given its $18 billion market capitalization before the story broke.
Deutsche Bank says it “has no intent to settle these potential civil claims anywhere near the number cited.” Markets are spooked anyway. A fine much above $3 billion would strain an institution that faces potential payouts in other regulatory cases, and the bank has already settled claims for billions of dollars for the likes of alleged interest-rate rigging. That includes Deutsche’s Bank’s $1.9 billion share of the 2013 settlement of the bizarre U.S. claim that numerous banks somehow deceived the sharks at Fannie Mae and Freddie Mac.
Chancellor Angela Merkel’s government insists no bailout will be forthcoming, and Berlin may even mean it. New European Union rules make bailouts harder to execute, and Berlin blocked Italy’s attempts to rescue its struggling large banks earlier this year.
Most of the risks now cited to explain Deutsche Bank’s woes are well-known, including its long struggle to reorganize to boost profitability amid ultralow interest rates and sluggish global growth.
Markets concluded these risks are manageable, although at a large discount to the share price in 2014.
The bank’s results in the recent European Banking Authority stress test were in line with other large banks, and it has been working to increase capital.
The new imponderable is the U.S. settlement raid that’s among the largest it has demanded.
The huge fines rest on a dubious theory that government prosecutors know better than investors how assets ought to have been priced in a market mania 10 years ago. And with a handful of exceptions (none at Deutsche Bank), regulators haven’t found individual bank employees who committed prosecutable crimes in the mortgage mess. These bank robberies are political.
Some Europeans think the Deutsche Bank raid is American retaliation for the EU’s August ruling that Apple owes back taxes of €13 billion in Europe. But Washington doesn’t need that incentive. The Obama Administration has also been merrily plundering American banks to satisfy the retribution demands of the Bernie Sanders-Elizabeth Warren wing of the Democratic Party.
The evidence hardly matters because the cases never go to court because no bank can afford to resist the government’s orders in a post-Dodd-Frank regulatory world. This is the latest morality tale in modern systemic risk. Government caprice has become a major risk, and maybe the major risk, to the global financial system.
US banks hold top five places in global investment ranking
Deutsche slips to sixth position, while Credit Suisse drops from seventh to eighth place
by: Laura Noonan, Investment Banking Correspondent
Morgan Stanley’s rise to fifth place marks the first time that US banks have monopolised the league tables since Coalition began the series in 2011, and highlights the country’s dominance of investment banking since the financial crisis.
Coalition’s data show that the bank lost most ground in fixed income, currencies and commodities trading, where Deutsche was a top three operator last year but fell to sixth in the first half of 2016. The bank also lost ground in equity capital markets.
Deutsche said: “The Coalition results reflect the strategic decisions we have taken to streamline our products, geographical footprint and client base. These decisions impacted first-half revenues but will make us more efficient and profitable. We remain the leading non-US investment bank globally and a top two player in Emea.”
Senior bankers privately admit that the internal turmoil at Deutsche in recent years has distracted bankers from their day-to-day business, but they say this is now fading.
They also say that while it will take time for the bank’s 2015-2020 transformation to bear fruit, they remain optimistic that the German lender can recover at least some of the ground it has lost.
However, the setbacks keep coming, including last week’s revelations that the US Department of Justice has put an initial price tag of $14bn on settling allegations that Deutsche mis-sold US mortgage bonds, which sent the bank’s shares down more than 7 per cent in just a few hours.
Credit Suisse, the other large European investment bank that is in the middle of a significant restructuring, also suffered in the first half of the year, slipping from seventh to eighth, swapping places with Barclays.
Biden Demands the Impossible of Ukraine: End Corruption
Sanctions against Russia aren’t working and the U.S. is forced to consider a new approach.
By George Friedman
U.S. Vice President Joe Biden has said that unless Ukraine overcomes its problems with corruption soon, the United States might have no choice but to abandon sanctions against Russia, Reuters reported yesterday. He pointed out that five unnamed European countries were opposed to continued sanctions and that any one of them could veto sanctions by the European Union. Given that sanctions have to be renewed by the end of the year, this doesn’t give Ukraine much time to abandon a very old national tradition.
The problem for the United States is that it supported replacing the old Ukrainian regime precisely because it saw the old regime as corrupt. Whether the United States really expected a change depends on who you spoke to. From my point of view, corruption was so deeply embedded in Ukrainian culture that it could better be called a way of life than a criminal deviation. But it was the major justification for backing demonstrators against the old regime and defending the new regime against Russia’s reaction.
The United States has a moralistic streak that manifests in odd ways. There are regimes the United States will not cooperate with because of corruption. There are also regimes where it will intervene in some way to make them less corrupt. And it will pass laws against Americans doing business with some of these regimes. Along with corruption, the U.S. opposes regimes that display brutal oppression. The United States intervened in Libya to end brutality and corruption. It is not obvious that the situation has improved. It is rare to find a situation where the U.S. has intervened in a country and achieved the desired outcome. Ukraine isn’t one of them.
Vice President Joe Biden shakes hands with Ukraine President Petro Poroshenko at a bilateral meeting during the 2016 Nuclear Security Summit in Washington, D.C. on March 31, 2016. JIM WATSON/AFP/Getty Images
The United States’ other problem is managing its failures – something with which it has some experience. Sanctions were imposed on Russia to try to force it to stop acting against Ukraine. The narrative was that Ukraine was a struggling liberal democracy fighting its corrupt oligarchs, while facing Russian aggression. The sanctions didn’t work in the sense that the Russians continued to pursue their course and, it might even be said, increased their aggressiveness. The United States likes to impose sanctions when it doesn’t want to do anything more decisive. Sanctions sound impressive but don’t put the target in a position where it might respond in unpleasant ways. The sanctions bothered Russia, but compared to the decline in oil prices, they hardly registered.
But abandoning the sanctions would make the United States look weak – even though imposing sanctions as a response to Russian aggression was already a sign of weakness. Agreeing to abandon sanctions without reciprocal Russian concessions would be a defeat for the United States. But Russia is not in any mood to make concessions. First, Russia is under deep economic pressure and needs foreign policy victories for domestic psychological reasons. Second, Russia has no reason to make concessions. It has lived with the sanctions thus far, and Europe is unlikely to continue with them much longer since they are causing serious problems there, perhaps as much as in Russia.
Biden clearly understood this problem, claiming that five European countries were ready to veto sanctions. Russian media reported that these countries were Cyprus, Austria, Hungary, Italy and France. I don’t know if this is true, but a lot of business is conducted between Russia and the European Peninsula, and its disruption has had consequences. Russia buys many goods from Europe, from agricultural products to machinery. The sanctions have disrupted the trade and at a time when economies around the world are sluggish, even small increments of exports matter.
Britain will likely be leaving the EU due to Brexit and some figures in Europe have spoken of expelling Hungary from the bloc because of its stance on immigration. If the EU, whoever the remaining members might be, continues sanctions on Russia, the cost will be unevenly spread. The EU’s ace in the hole has always been the subsidies given to some countries. But as the cost of membership rises, the attractiveness of remaining in it will decline.
The United States does not want to see the EU fragment. To the extent that the United States relies on NATO, it requires a roughly aligned Europe. In addition, the financial crisis Europe is facing can always impact U.S. markets in some way. No matter the barriers in place, Europe cannot have a financial crisis without affecting the United States. The U.S. cannot do much to solve the financial crisis, but it is willing to do what little it can.
The United States has a complex relationship with Germany. U.S. and German strategic interests do not align in many cases, but to the extent the U.S. doesn’t want chaos in Europe, Germany is the center of gravity that can hold it together. At the same time, it would not like to see Germany and Russia too close. Nevertheless, Germany is now entering a dangerous phase of economic danger, and the U.S. can’t welcome German instability. Germany and Russia have long maintained close economic relations and Germany is uneasy with the sanctions, moving in different directions on them at the same time.
The primary stated goal for the U.S. – creating a Ukraine without widespread corruption – has failed, and it was always obvious it would fail. The United States’ other goal was to prevent Russia from dominating Ukraine, but the sanctions are of little value in achieving that. They are hurting several European countries and the enthusiasm for them, never particularly great, is now reaching the point where the Europeans will abandon them. But the U.S. doesn’t want an EU rejection of the sanctions regime to be the reason it abandons this tactic. So Biden has opened the door for a U.S.-led end to the sanctions by stating that Ukraine must remake its soul in the next few months or the sanctions might be eliminated.
The question of how Russia will approach Ukraine without the sanctions was not addressed in Biden’s comments. But the sanctions were clearly not a decisive force. For Russia, Ukraine is of fundamental interest as a buffer against the West. For the Americans, Ukraine is of fundamental interest as a buffer against the east. The United States cannot get a corruption-free buffer, but it could likely negotiate a neutralization of Ukraine, in which Ukraine can have a Western-friendly government and economic ties with the West, but would not align itself militarily with the U.S. and EU. In return, Russia would abandon its insurrection in eastern Ukraine – which is not going anywhere anyway – and find some formula in Crimea for maintaining its original treaty rights there with some political accommodation.
Abandoning sanctions before they abandon the United States makes sense. But it is an ad hoc solution, in which the Europeans are driven to a decision by the need for unanimity, and the U.S. is compelled to abandon a policy because of the EU’s internal dynamic. In my view, the sanctions were always both ineffective and unimportant, but how they are abandoned matters in terms of the perception of U.S. reliability. In the meantime, the U.S. should stop asking nations to do things they can’t do. Ukraine is Ukraine, and unlike the United States, which has no corruption anywhere (or so it would like to believe), Ukraine does have a great deal. And this won’t change.
Les doy cordialmente la bienvenida a este Blog informativo con artículos, análisis y comentarios de publicaciones especializadas y especialmente seleccionadas, principalmente sobre temas económicos, financieros y políticos de actualidad, que esperamos y deseamos, sean de su máximo interés, utilidad y conveniencia.
Pensamos que solo comprendiendo cabalmente el presente, es que podemos proyectarnos acertadamente hacia el futuro.
Gonzalo Raffo de Lavalle
Las convicciones son mas peligrosos enemigos de la verdad que las mentiras.
Quien conoce su ignorancia revela la mas profunda sabiduría. Quien ignora su ignorancia vive en la mas profunda ilusión.
“There are decades when nothing happens and there are weeks when decades happen.”
Vladimir Ilyich Lenin
You only find out who is swimming naked when the tide goes out.
No soy alguien que sabe, sino alguien que busca.
Only Gold is money. Everything else is debt.
Las grandes almas tienen voluntades; las débiles tan solo deseos.
Quien no lo ha dado todo no ha dado nada.
History repeats itself, first as tragedy, second as farce.
We are travelers on a cosmic journey, stardust, swirling and dancing in the eddies and whirlpools of infinity. Life is eternal. We have stopped for a moment to encounter each other, to meet, to love, to share.This is a precious moment. It is a little parenthesis in eternity.
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