As I have written many times over the past three years, the societies and economies of the western world are going through a period of transition from an age where we thought we could buy prosperity for almost everyone, to an age … well, we don’t know the answer to that yet.
Coming out of the World War II period, the United States government decided that it could achieve greater equality of wealth and opportunity in the country if it (1) underwrote high levels of employment by constantly inflating the credit of the economy, (2) subsidized home ownership so that more and more Americans could own their own homes, and (3) by providing generous pensions to people though direct governmental programs or subsidized private sector initiatives.
Today we have the largest degree of income/wealth inequality in the United States since the early part of the last century; we have experienced the worst period of severe price deflation that the housing sector ever experienced where even now 22 percent of the homeowners with mortgages find that their home prices are below what they owe on their mortgages; and many pension funds, both private and public, are underfunded to such a degree that grave concerns exist about their viability.
The pension funds of private corporations have been hurt by the very low interest rates that have existed in the financial markets for the past several years. Given such low investment returns these companies have found it difficult to make the returns they need to fund their obligations.
One solution to this problem has been to leverage up the pension funds with low cost debt so as “to reduce financing costs, extend our maturity profile and manage our liabilities” said Dave Vajda, vice-president, chief risk officer and treasurer of NiSource, an energy company that issued bonds in 2011.
Companies are not “earning” their way out of their pension problems. Currently, they seem to be using “borrowing” to fill the gap. CSX (CSX), Kroger (KR), Raytheon (RTN), and NiSource (NI) are just a few companies that have recently followed this path. Still, JPMorgan estimates that corporate pension plans are only about 77 percent funded.
But, the problem appears to be even worse in the public sector. I have written about the situation of state and local governments numerous times over the past two years or so. Research has placed the shortfall in the $3-to-$4 trillion range with others saying that $4 trillion is only a lower bound. Whatever the number is, most agree it is substantial.
There seems to be several reasons for this situation. First, state and local governments don’t like to use mark-to-market accounting to realistically price their obligations. Second, many state and local governments are still using assumptions about investment returns that are delusional, at best. Most state pension plans use the assumption that their investment portfolios will earn an 8 percent annual return, this at a time when 10-year US Treasury securities are returning about 2 percent per year.
Additionally, state and local governments have been notorious for using methods to cover-up the position of their pension plans in the face of budgetary requirements to balance budgets and so forth. The Government Accounting Standards Board, which oversees government accounts, has been sleepy, at best, in the past. There is some indication that this group is beginning to show some life.
The point is, that there are still pockets of problems lodged within the United States economy that need to be worked out going forward. And, the working out of these problems is not going to be simple and easy.
Another factor contributing to this problem is that the “social model” that has served as the foundation for these programs (pensions, unemployment, housing, and so forth) is changing. Mario Draghi, President of the European Central Bank, stated yesterday that the “Social Model is Gone”. He was referring specifically to the European Continent, but it applies to the United States as well.
One further problem faced by the pension programs in the United States is that many people are taking early retirement and this fact was not built into the pension schemes. The reason why many are taking early retirement is that organizations, both in the private sector as well as in the public sector, have been downsizing to meet budgetary needs and this downsizing has resulted in the fact that many who have left these companies are people eligible for their full pension benefits.
This situation is particularly acute in the public sector as employment in government in the United States dramatically increased over the past fifty years while labor unions became very active in the state and local government bodies. Now, over fifty percent of the members of labor unions in the United States reside in the public sector.
This is all changing. We have no idea right now where this change will take us. The difficult part of this, however, is that there are obligations outstanding right now that need to honored in one way or another. All we can say, at this time, is that the transition is not going to be easy.
There are many of these “little” problems, here and there, that we have built into the United States economy that must be worked off. How they are worked off can affect the economy and financial markets in many ways. But, these little problems don’t always get the headlines because the emphasis of the press … and the politicians … is constantly to find the “green shoots” that indicate that the real economy is picking up steam.