Sunday, October 3, 2010

Federal Reserve Policy Transfers Municipal Pension Wealth to Banks Too Big to Fail

The Federal Reserve Bank's near zero interest rates are impoverishing publically held pensions.

To permit Federal Reserve member banks to maintain profitable margins in a deflationary real estate, oil, equities, and big ticket consumable items (like cars) environment, the Fed. has kept interest rates historically low. This, in turn, has kept the return on bonds low. The result is that, despite a 25% recovery in the equities market, publically held pensions are neck deep in red ink.

The Troubled Asset Relief Program series of 700 billion dollar bailouts is not the only cost taxpayers are bearing to save institutions that should have failed. After all, taxpayers have earned back and been paid back almost 9 billion and almost 200 billion of the TARP authorization has not been lent out. Five hundred billion to save the world economy is chump change in 2009.

Of course, the bailouts have cost more. The 182.3 billion AIG bailout must be considered. Additionally, the FDIC insurance fund's spending to cover horrendous banking losses and looming liabilities (136 institutions added to the "problem" bank list making a total of 552) cost the U.S. treasury, in 2009, indirectly another 40 billion. Ok, just because I know how mad you all are, go ahead and include the 60 billion in the Chrysler and GM UAW bailout. In sum, that's about $780 billion. To save the world economy, it only cost the U.S. tax payer 780 billion dollars. What a deal. That's cheap, or so we're reassured by top government banking executives.
But this $780 billion dollars is less than half of the potential future cost of the unfunded, unlegislated, and unspoken Federal Reserve bailout policy that has continued now for over a year. This Fed policy of all but 0 interest rates, of printing money so fast that paper and ink commodities are out of sight, and of debasing the dollar until it's a debacle has one very clear price tag. While banks are still floating above a sea of funny money, publically held U.S. are going under to the tune of another two trillion dollars.

While the reduced value of assets held by pension funds are partially to blame, the low interest rates of bonds presents the most serious dilemma. Orin Kramer estimated (my emphasis) that public pension funds base their numbers on actuarial assumptions that use "8% returns a number that is ridiculously high in a zero-rate environment" but which still yields, especially in relationship to the market values in 2008, an aggregate $1 trillion deficit for public funds. Kramer, using current asset market values and a more conservative investment yield rate, says public pensions are currently underfunded by two trillion dollars.

It is important to note that Kramer's appraisal is that of a political fund raiser running a New Jersey pension. This is important because of the self-serving nature of Kramer's estimate. If pensions, in his estimation, are a trillion short, it follows that if the New Jersey pension Kramer runs is suddenly really short, it isn't his fault. Nonetheless, the relationship between typical yields and current yields in the Federal Reserve bailout era presents the horns of dilemma, not only to public but to private retirement funds.

In 2008, the financial meltdown's negative affect on stock prices, dropped U.S. public pension assets by more than a trillion dollars. Even though things have begun to slowly turn around for equities in 2009, conservatively, the returns for pensions are under 200 billion. Even though the turn around is slow, the dilemma for pensions is that the low Fed rates, savings rates, and bond rates make the higher risk stock market seem attractive. The Federal Reserve's policies, combined with the natural reliance of pensions on bonds is bring down the public retirement system. The last time U.S. pension funds saw a surplus was in May 2008. Since then they have had "19 consecutive months of deficits as markets reacted to the financial crisis" (Mercer).
Sometimes it is tempting to think that the trillions the U.S. Government is tossing around are as meaningless as phony campaign promises. The numbers can't be real. No one believes them. Sorry, the sad part is these insanely stupid acts, unlike the insanely stupid things candidates say, do have consequences. Bailing out the financial system is already costing private and public pension funds far more than the advertised $780 billion price tag.

What might have happened if McCain had led a revolution saying no to TARP, no GM, no to Chrysler, no to AIG and no GMAC? Would the DOW have gone to 2,000? Would the pensions have declared bankruptcy? Would the public, in outrage put the public lynching of Fannie and Freddie on UTUBE and would we have stormed the Bastille? Maybe, but maybe not. It does seem evident that the cure is killing the patient --slowly.

As gloomy as is all this news, the situation is probably far worse. Consider for instance, the House Banking Reform Bill with the Orwellian title "Wall Street Reform and Consumer Protection Act." This bill anticipates future bailouts at as much as four trillion apiece. Sure, we've got that kind of money lying around. Sure, no problem. (See also my article on what a banking reform bill should look like).