Reaching for yield

The unfunded liabilities of the San Diego County Employees Retirement Association have increased every year for the last five years, reaching $2.45 billion last year, more than quintuple the level in 2008. The calculation of how big the shortfall is assumes that the fund is going to be able to earn a 7.75% return on its investment after subtracting administrative costs. If it earns less than 7.75%, the shortfall will be even bigger. A 10-year Treasury bond currently pays 2.4%, and a typical stock has a dividend yield under 2%. So what do you do if you’re in charge of the system’s $10 billion in assets?

One thing you could do is ask the taxpayers for more money right now.

What the SDCERA board did instead was to approve a strategy that is supposed to increase the return on the fund’s assets.

And how do you do that, exactly? Suppose you invest $50,000 outright in the S&P 500. If the market goes up 1%, next year it will be worth $50,500, and you’ve earned 1% on your investment. (I’m going to ignore the role of dividends, which complicate a little the calculations I’m about to describe, but don’t change the basic story.)

Or you could use your $50,000 to cover the initial margin requirements for a couple of S&P 500 futures contracts, which would have a notional value of around a million dollars. That means that if the market goes up 1%, the notional value goes up to $1.01 million, and you get to keep all the $10,000 gain for yourself. That’s a 20% return on your initial $50,000 investment– not bad money in a ho-hum market!

Unfortunately, the downside is that if the market goes down 1% rather than up, you lose 20% on your investment. Oh well, what’s life without a little excitement?

The San Diego Union Tribune and the Wall Street Journal reported last week that the board of directors for the San Diego County Retirement Employees Retirement Association has decided to use more strategies like these to increase the funds’ effective leverage to around 100%, meaning when the underlying investments go up 1%, the fund earns 2%, and when they go down 1%, the fund loses 2%.

Now, there are two reasons you might give for such a strategy. The first is you’re really, really good at making the right picks, so we’ll only magnify positive returns and never magnify a negative return. Of course, these are the same folks who lost big on the Amaranth hedge fund fiasco. But maybe they’ve learned from past mistakes, and this time they’ll get everything right.

Or a second argument you could give is that the county pension fund is particularly well suited to take on extra risk, having (you think?) a base of taxpayers quite willing to fork over the extra funds necessary to cover the additional shortfall we’ll experience in a down market, even though they’re apparently not willing to pony up the funds for the shortfall that’s already on the books.

Here’s what Barry Ritholtz thinks:

I am not fond of forecasts, so instead, I will offer one of two likely outcomes: Eventually, San Diego County’s pension fund blows up. The losses are spectacular, and the county taxpayers are saddled with billions in new tax obligations. Alternatively, the townsfolk figure out how much risk is being put on their shoulders, and fires everyone involved, from the pension board to the advisers to anyone who voted for these shenanigans.

I have seen this movie before. I know how it ends.

34 thoughts on “Reaching for yield

  1. PeakTrader

    It’ll likely be quite a while before there’s another spectacular structural bull market like 1982-00.

    And, I wonder how much upside there is in bond and stock prices at this point?

    U.S. and global economic growth will likely be slower in the future.

    Of course, there may be a Biotech Revolution that rivals the Information Revolution.

  2. Benoit Essiambre

    What is bad about this strategy is the large risk externalities and moral hazard. There is a chance it might actually work for them but the chance it works for any pension fund diminishes as more funds adopt the strategy and the procyclical forces inherent in all this leverage results in high probabilities of the whole thing blowing up. This type of leverage should be illegal for all pension funds and large institutional investors (and a bad idea for most small investors also). They should not be allowed to compete with each other by taking an ever growing amount of risk and putting the whole economy in danger.

  3. Jay

    “One thing you could do is ask the taxpayers for more money right now.”

    But that would mean admitting that they should have been accruing greater non-cash compensation benefits for public sector employees. Which in turn will require Proggers to amend their studies comparing private v public sector compensation and admit that public sector employees are better compensated ceteris paribus.

      1. c thomson

        ‘rentier, globalist leaches’ – and with leeches misspelled? magnificent! classic snivel! everyone but some sixth grade teacher should be proud…

        1. Nick G

          That’s a nitpick, instead of an answer.

          Whenever someone uses a “you vs them” term like “progger”, we can tell they’re not thinking independently and objectively. Instead, they’re following a thought leader of “their” group.

  4. jonathan

    Another issue is illiquid investments. A big chunk of reported gain is often in illiquid investments whose value is guessed to market. If you sell at the right time … but if you need cash, then …

    I know some state pension funds have this issue. S. Carolina for example.

    1. John Cummings

      they want to play the casino, you better get out before it falls. The real problem begins after you have had a few good years, which creates the complacency.

  5. AS

    Where are the actuaries on this decision? I am amazed that actuaries approve such a risky maneuver, since actuaries are the ones who calculate probability expected discounted pension liabilities based upon an assumed rate of pension return (and risk of earning the expected return). When I was a member of a pension committee many years ago, the actuaries used either current expected reasonable returns with reasonable risk or used an averaging system to smooth the returns over time. I seem to recall there was a ten year average method. Maybe if there are any actuaries who read this blog, we could be enlightened.

    1. dwb

      Actuaries (being people with families to feed) are not immune from incentives. There is a strong incentive for pension boards to shop around for assumptions (because they are also fighting off proposals to change to hybrid 401k style pensions, or reduce benefits altogether), a strong incentive for consultants like Aon Hewitt to tell boards what they want to hear, and a strong incentive for actuaries to go along to stay employed and please the client and their employer.

      It’s beyond the scope of a mere comment, but if you want to know the risk of a pension you need to do simulations across asset classes, not mere static probability-adjusted expected discounting based on (static) risk adjusted returns. Some software is set up to do this, some not.

      Banks are now forced to look at their downside pension risk for economic capital purposes. That was because regulators forced them to.

      Were the rates of return “reasonable”? based on what? A power point that said., hey, everyone else is using these assumptions, so it must be reasonable? Because these asset classes achieved these rates over the last 30 years (when inflation, aggregate demand, and interest rates were significantly higher)? If the standard deviation of returns in any given year is 20%, how would you even know the number was wrong with any certainty?

  6. dwb

    This is a real problem for a lot of pension funds, not just San Diego. Not the leverage** – the strategy is a symptom of a larger problem. Pension Boards are rarely independent enough to admit that a 7.75% return on its investment after subtracting administrative costs is unrealistic in this low return world. Maryland’s target is a little lower (7.55% I recall). They hit it for a few years, and then don’t (and the “don’t” is big). Maryland has its own version of this problem- a chunk of money invested in “credit strategies.” As a market risk officer at a large bank, let me tell you anything labeled a “strategy” immediately makes my neck hairs stand up.

    Aon Hewitt, or whatever other consulting firm looks at these returns, are generally well skilled at telling the board what they want to hear. As in, look, other pension funds make the same unrealistic assumptions you do. Been there, done that.

    The reason Pension Boards don’t want to mark down returns is that it blows up the liability. And if the liability looks too big, benefits get cut and contributions go up, and it adds fuel to critics who want to switch to a 401k hybrid. Budgets are just too tight to, uhh like actually fund those liabilities, even under the optimistic high return 7.5% scenarios. And, the economy is not good enough nor is the electorate in the mood to support more taxes. Maryland actually reneged on its deal to fund pensions and actually cut pension funding over the last two years, even though they spent plenty elsewhere. A very shortsighted strategy tactic that puts even more pressure on future stock market gains.

    Pension boards and unions are fighting tooth and nail to prevent the inevitable rise in contributions and switchover to a 401k hybrid system.

    So, instead of marking down returns to more realistic levels, which would highlight the gap and give opponents ammo, they hold on to unrealistic returns. That puts pressure on managers to invest in sketchy “credit strategies” or leverage.

    **Keep in mind btw on “leverage” they are merely working around the Pension-Board mandated asset allocation. So for example if the board targets 25% in equities, 75% in bonds, then this boosts it effectively to 50% equities. (I cannot say for San Diego, but 25-45% equities is typical (and the % is a function of median-years-to-retirement). In an of itself its not a bad thing. If they were honest they could just eliminate leverage and adjust the asset allocation. The fact that they feel they need to do this on the DL to boost returns is the real problem. If people saw a sudden jump in equity allocation, they would say WTF.

  7. 2slugbaits

    Well, hold on. Aren’t there two different issues here? The first issue is taking on more risk in order to achieve a higher return. I don’t think there’s anything inherently irresponsible in asking the fund managers to include riskier assets in their portfolios. Afterall, this is a portfolio of assets, not a single holding of Treasury securities. I’m not a finance guy and quite frankly back in my college daze finance kind of bored me to tears, but I do recall something or other about accepting riskier individual assets if those assets were negatively correlated with the rest of your portfolio. A lot of pension funds have not always had the flexibility to include riskier assets even though doing so could actually reduce the overall risk of the portfolio. But the second issue is more troubling, and that is increasing leverage. Now that is an unqualified invitation to disaster.

    At the macroeconomic level, this issue of retirement funds of all flavors (be they public sector pensions, private pensions, personal 401k plans, etc.) with respect to reaching for yields has some counter-intuitive aspects. As the private sector sheds pension plans and puts more of the retirement savings risk on workers with portable 401k plans, the greater will be the level of required savings across the entire economy. This is because greater reliance on 401k plans at the expense of pension and Social Security benefits increases the need for individual precautionary savings above and beyond the mean estimate for retirement. Hello secular stagnation. The sad irony is that in cases like the San Diego pension plan for public sector workers the voters’ first instinct is to want to cut back public pensions. Wrong, wrong, wrong, wrong, wrong! That only drives down the already low rate of return on 401k plans. A better solution would be to expand pension and Social Security benefits, thereby making future retirees less inclined to over-save during their working years. This problem is made even worse as young people come to believe (wrongly) that Social Security will not be there for them when they retire. If they truly believe this, then they will entirely discount future Social Security benefits and over-save in personal retirement accounts. This is inefficient and simply pushes down interest rates…which then encourages risky leveraging and “reaching for yield” schemes like the one in San Diego county.

    1. PeakTrader

      Shifting to 401(k)s hasn’t caused households to save too much for retirement.

      Public employees need to receive less or pay more, and governments need to spend less or tax more.

      It’s easier to spend and borrow than to save, particularly with low prices and low interest rates.

      However, do we really want high prices and high interest rates?

    2. c thomson

      Some muddle here by 2slugs.

      An S&P option is hardly uncorrelated with the other quoted US financial assets that the plan holds. This is just doubling up on red.

      Anyway, in a financial meltdown correlations of 1 across a wide range of assets are likely. DWB is spot on. And of course it will be necessary eventually to cut return assumptions, payouts AND raise contributions. The hope is that this is done prior to a Detroit scenario.

  8. Jeffrey J. Brown

    “Net Export Math & Government Pensions

    Export Land Model (ELM):

    For a hypothetical net oil exporting country “Export Land,” as production is increasing, if the rate of production exceeds the rate of increase in consumption, the rate of increase in net exports (production less consumption) will exceed the rate of increase in production. But given an ongoing decline in production, unless they cut consumption at the same rate as the rate of decline in production, or at a faster rate, the resulting net export decline rate will exceed the production decline rate, and the net export decline rate will accelerate with time.

    For government entities, let’s assume that tax revenue is analogous to production and let’s assume that current and former employee expenditures are analogous to consumption.

    The GELM (Government Export Land Model)

    Let’s think of local and state (provincial), and for that matter, national governments as being similar to oil exporting countries, in that they consume a percentage of tax revenues, in order to pay current benefits to employees and operating expenses and to pay current and future retirement/health benefits.

    And let’s just really focus on current and future retirement benefits.

    As Michael Lewis noted in his recent book, “Boomerang,” a lot of local governments, especially in California, are on track to consist of little more than a small staff that collects taxes and forwards virtually all tax revenue to retirees. And of course, most public pension systems are assuming a (highly unrealistic) estimate of 7% to 8% on future annual returns. Of course, the lower the actual investment return, the larger the unfunded pension obligation.

    In any case, if we assume flat to declining tax revenue, combined with rising retirement obligations (especially as investment returns continue to disappoint), it seems to me that the net result would be an accelerating rate of decline in services provided to the taxpayers, perhaps even as governments try (probably) unsuccessfully to materially raise tax revenue, by raising tax rates.

    Detroit aftershocks will be staggering
    Leaders across the country cannot continue as they have, says Meredith Whitney

    As jarring as the reality may be to accept, Detroit’s decision last week to declare bankruptcy should not be regarded as a one-off in the US municipal market – which is what the bond-peddlers are now telling their clients. The aftershocks of the largest municipal bankruptcy in US history will be staggering, and Detroit will set important precedents. Municipal bankruptcies have historically been rare for a number of reasons – including the states’ determination to preserve their credit ratings, their access to cheap funding and the stigma of bankruptcy. But, these days, things are very different in the world of municipal finance.

    At the root of the problem is the incentive system that elected officials used to face. For decades, across the US, local leaders ran up tabs for future taxpayers; they promised pensions and other benefits for public employees that have strong legal protection. That has been a great source of patronage for elected officials: they can promise all sorts of future perks to loyal supporters (state and local workers) with very little accountability on the delivery of those promises.

    Today, we are left with the legacies of this waste. The bill for promises past is now so large for some cities and towns that it is crowding out money for the most basic of services – in the case of Detroit, it could not even afford to run its traffic lights. Across many American cities, cuts to basic social services have already been so deep that they have made the communities unpleasant places.

  9. dwb

    So, looking at San Diego Asset Allocation here:,_Drops_Bonds.html
    and their statement here:

    Based on their statement, leverage is contained in 25% of the portfolio. That 25% of the portfolio will most likely behave like something in the other 75%, most likely equities. Total equity allocation is 20%, so I would say this is highly likely to boost it to 45% assuming a 2:1 leverage ratio. If they put it in commodities, or “real assets” (usually real estate), those assets will behave just like equities when global demand tanks during a recession, so I am simplifying some. To put this in perspective, MD’s pension assets are 42% in equities.

    I disagree with “SDCERA is answering the real concern impacting public pensions by using tried and true principles of asset liability management and diversification, and not relying heavily on more volatile equities to close this gap.”

    Of course they are. But I also disagree with Ritholz that this is likely to blow up or taxpayers figure out the risk. The risks here (based on the asset allocations I googled) are not more than just placing 45% in equities and calling it a day. The real risk is that asset values plummet at the same time the pension needs to pay retirees – a bona fide cash crunch. To know that risk you would need to know the median time to retirement. If the median time-to-retirement was 3 years, I’d say its a big risk. Maryland has 42% in equities but also a median time to retirement of 10 years (ish).

    As I said, I don’t see a reason to hyperventilate about leverage, but I see this as a symptom of a larger problem not limited to San Diego. It even infects deep blue Maryland.

  10. Ricardo


    Consider your post in the light of a 2% inflation rate the amount that many demand side economists see as necessary. What this means is that any ROI less than 2% means that there is a loss in the real economy. The inflationist theory forces the average person to become a risky speculator. Anyone who does not engage in risky speculation loses. My parents and grandparents put their money into fixed investments with low returns because they had no fear of inflation eating away their gains. Under the inflationist theories of today this is not possible.

    The problems being faced by the San Diego County Employees Retirement Association are larger than what the average person faces but the problem in not unique today.

  11. baffling

    “The inflationist theory forces the average person to become a risky speculator. Anyone who does not engage in risky speculation loses. ”

    incorrect. you can put your money in a 10 year treasury and break even. if you want to make money, you need to take risk. the baby boomer mentality of yield entitlement without risk is astounding!

    “My parents and grandparents put their money into fixed investments with low returns because they had no fear of inflation eating away their gains.”
    I would bet they did not even understand the risk of inflation. but chances are they lived through the great depression, when assets were completely lost and deflation ruled. hence they adopted the safe approach that capital return plus a little extra was a great outcome.

  12. JBH

    Here are some germane points. (1) Nobody on the fund’s board, nor to whom they might outsource, can consistently and correctly call the direction of the stock market. There are skilled investors out there. Mostly managing hedge funds. Best bet would be to pick one of them. But that just pushes the problem back a step. Why would the SDCERA board remotely expect they have the skill to pick a top fund manager who can do the job for them? (2) They should absolutely be disabused of the notion of using leverage. Too much leverage is what took Bear and Lehman down. (3) There is always a sweet spot on the yield curve. This is the point of highest yield at lowest risk for that yield – a spot that in the future will prove to have been the best place to have been. But making the decision in real time is the trick.

    Correctly judging where the sweet spot on the yield curve is at any given point in time is a rare art. It requires years of experience. At this present moment, we “know” it is not in fed funds. We know it is not at the other end of the curve in 30-year bonds. It is somewhere in between. But where? I always have a judgment as to where, but there is no reason a complete stranger should have any confidence in my view. What it takes to have an informed view is an understanding of where the base of the yield curve (fed funds) is going, when it is going, and at what rate of movement. And also an informed judgment about the various spreads off of fed funds and, as well, how they will move over time. The fed-funds 2-year yield spread is easiest, but requires being a student of history schooled enough that you can distinguish how the 2-year would normally move at this point in the rate cycle, and then be able to modify this understanding with what is new and different about today’s current environment. Further up the curve is the fed funds 10-year spread. This spread is, in general, determined by different forces than the ff-2yr spread. And – this is quite important – over time some forces come into play and then after a while they wane. So historic context is vital. Right now, for example, the Ukraine is affecting the ff-10-yr spread. Many basis points are being eroded out of the spread by the geopolitical tension in emanating from the Ukraine which is inducing flight to safety by global investors into US Treasuries. Prediction: If and when all tension in the Ukraine is more or less permanently resolved, the spread will have moved significantly wider than where it is now. (Unless some new factor of similar magnitude enters the market!) Of course, the everchanging economic fundamentals are integral to the spread as well. The most crucial right now being the forward prospects for PCE price inflation. As this is what is going to determine the Fed’s next move, as well as movement of the various spreads (maturities) moving up along the curve.

    A caveat. Fed funds futures are a poor guide to the future, though better than nothing. Every banker in the country would like the answer to the question posed by this post. Large tier I banks can avail themselves of sophisticated options strategies to narrow down the risk. But the base problem is, when all is said and done, a call for the most accurate interest rate forecaster in the country. And even that individual, were you able to locate him or her, can never be wholly right in a consistent manner over time.

    What ought the SDCERA board do? If the board does not propose raising taxes – or cutting benefits – to address its problem, it is abdicating its responsibility. The sooner it acts the better. Where elsewhere at the national level do we see this kind of abdication writ large!

  13. 2slugbaits

    c thompson I think you misunderstood my point. I was simply pointing out that incorporating riskier securities into a portfolio is not in and of itself inherently irresponsible provided that those riskier securities are negatively correlated with the rest of your portfolio. Whether or not the pension managers were allowed or able to find negatively correlated assets is another question entirely. The “allowable” issue is a legal one. The “able” issue is an empirical one.

    Peak Trader In today’s world of a ZLB global savings glut I don’t think you can argue that 401k plans are helpful. I’m not saying they are primarily responsible for the global savings glut, but they do make a bad situation worse because they encourage an inefficiently high level of savings. Less savings, more consumption is what the doctor ordered. And if you are worried about the federal government’s deficit, then once again 401k plans are bad news because they shield income from the tax man. The tax code should not be encouraging schemes that divert compensation away from money wages. Finally, 401k plans are difficult to justify on Rawlsian “justice as fairness” grounds because most of the benefits go to upper-middle class income folks and shift the costs onto those who are in the lower quintiles. Bottom line is that 401k plans fail on fairness grounds, they fail on fiscal policy grounds and they fail on macroeconomic grounds in the new reality of secular stagnation.

    And just to be clear, much of the same criticisms apply to pension plans; both public and private sector. The combined weight of 401k plans, private pension plans and public sector pension plans all put downward pressure on interest rates. That’s great if you’re forever living in 1979. Not so great if you live in the post-Great Recession reality of secular stagnation. I would favor somewhat higher FICA taxes against higher money wages coupled with greater Social Security benefits to replace a lot of the inefficient (and now apparently risky) pension funds. More emphasis on a stronger Social Security safety net and less emphasis on 401k’s and pension funds.

    Recall that a lot of local and state governments started offering fairly generous retirement packages because they didn’t want to pay higher money wages. Generous retirement packages were a way of kicking the can down the road. Now those state and local governments are finding that the can is at the end of the alley and it’s time to pay-up. Myopic and amnesiac voters like to forget about those deals they made 30-40 years ago with public sector workers and are now looking for a way to renege on past deals. It’s what voters do. The problem is that the Lucas Critique applies to voters’ promises as well as Fed monetary policy. Public sector workers will be less inclined to accept the promises of generous pension plans if they believe those promises will be broken when times get tough. So they will demand higher money wages. Again, since voters can’t be trusted moving away from public sector pensions and towards an expanded Social Security program seems like the way to go.

    1. PeakTrader

      You’ve responded by changing the subject from overcompensated government workers, supported by undercompensated non-government workers, to economic growth.

      I stated before, U.S. consumers bought foreign goods and foreigners bought U.S. Treasury bonds. The federal government rather than “refunding” those dollars back to consumers in the form of tax cuts, to allow the spending to go on, spent them instead.

      To spur economic growth, a big “middle class” tax cut was needed for households to pay-down debt and raise discretionary spending, the cost of living needed to be reduced, temporarily, through deregulation, rather than raised, and the minimum wage should’ve been increased, to correct a market failure and reduce inequality.

      Low prices and low interest rates induce demand, through spending and borrowing. Moreover, lower input prices and a lower cost of capital raise production, ceteris paribus.

      1. 2slugbaits

        Peak Trader I’m assuming your comments were directed my way??? First, you seem confused about how much government workers earn. And which government workers are you talking about? Federal? State? Local? If you want a general rule of thumb, lower skilled workers (i.e., those with no more than one college degree or less) tend to make a little more in government service than they would make in the private sector. Higher skilled employees (multiple graduate level degrees) tend to make significantly less…orders of magnitude less. Those with middling skill levels (e.g., one or two master’s degrees) make about the same as they would make in the private sector. The main difference is that during economic recessions government workers are not impacted as much…although even that is changing. On the other hand, during economic expansions government workers tend to do much worse. For example, during the 1990s the government had a very difficult time recruiting and retaining workers because the pay gap had widened so much…on the order of 25% even after accounting for fringe benefits.

        The federal government rather than “refunding” those dollars back to consumers in the form of tax cuts, to allow the spending to go on, spent them instead.

        I’m sorry, but this is simply idiotic. So you’re trying to tell us that the tax cut multiplier is greater than the fiscal spending multiplier? Really? Have you learned nothing from Menzie’s many posts on this topic?

        a big “middle class” tax cut was needed for households to pay-down debt and raise discretionary spending

        You do know that those two things are in direct conflict with one another, right? Tax cuts (and especially simple “refund” checks”) will help households repair balance sheets. And in a balance sheet recession that could be a good thing. Of course, so would a debt jubilee. But a household cannot simultaneously use tax cuts or refund checks to repair balance sheets and raise discretionary spending. You can’t spend a tax cut twice. Oh by the way…the ARRA did have large tax cuts. And there was a follow-on temporary cut in the FICA tax.

        Low prices and low interest rates induce demand, through spending and borrowing.

        I see, so businesses in monopolistic competition try to increase output when prices fall. Sure they do. As to low interest rates, how much lower than zero can we go? News alert. The Wicksellian interest rate is negative. Zero isn’t low enough. Adding more savings to the loanable funds pool does not help in this case. What would help would be a little inflation. What would help even more is government demand for that pool of savings in the form of government investment demand. Right now the government should be the spender of last resort.

        1. PeakTrader

          2slugbaits, job security is one factor why government employees, in general, are overpaid.

          So, if your debt level is high, with high monthly debt payments, a tax cut wouldn’t help you much? How would a $5,000 refund from the government be used? Maybe, pay-off high interest rate credit card debt, catch-up on bills, or pay-off the remaining balance on a car loan, to lower monthly payments and raise monthly discretionary income. Almost all of it, if not all of it, would be spent each month, since your debt payments have been so high with little discretionary income left over.

          Interest rates are low, because private demand remains weak. The boost in government spending, with the small and slow tax cuts, failed to generate a self sustaining consumption-employment cycle. Clearing the market of excess private goods, e.g. through tax cuts, would’ve generated faster growth than creating a bigger market in public goods.

          Household debt levels are high, because of low prices and low interest rates. It’s perfectly rational to spend and borrow, rather than save, when prices and interest rates are low.

          1. baffling

            “job security is one factor why government employees, in general, are overpaid.”
            really? how so? ideological statements need to be backed up if they are to be taken seriously.

            “how would a $5,000 refund from the government be used? Maybe, pay-off high interest rate credit card debt, catch-up on bills, or pay-off the remaining balance on a car loan, to lower monthly payments and raise monthly discretionary income. Almost all of it, if not all of it, would be spent each month, since your debt payments have been so high with little discretionary income left over.”
            this argument is naive because it assumes the $5000 clears out the debt. most people would not be eliminating their debt load with a $5000 bonus-just shrinking their debt load. unless you eliminate the debt, you have not eliminated monthly payments so going forward your spending habits would be the same. if you don’t use the refund to pay off the debt, you get a little stimulus-but you also still have not reduced your debt either.

            “Household debt levels are high, because of low prices and low interest rates. It’s perfectly rational to spend and borrow, rather than save, when prices and interest rates are low.”
            debt levels were elevated years ago, before interest rates dropped. so people did not build up debt due to low rates and low rates. in fact, in housing debt level increased with higher prices and higher rates. your statement is false.

          2. PeakTrader

            baffling, government workers are less likely to be laid-off, including in a recession, and government entities rarely go out of “business.”

            Well, if $5,000 doesn’t clear up the debt, they can spend it. Why would anyone make payments in advance, for example, without paying-off a loan or reducing their monthly payments?

            Everyone uses money the best way they can, and that fit their needs.

            And, higher asset prices contributed to the high level of consumption and borrowing in the disinflationary 1982-07 “long boom,” with declining interest rates.

          3. baffling

            “government workers are less likely to be laid-off, including in a recession, and government entities rarely go out of “business.”
            you still do not explain how this translates into government workers being overpaid due to job security. try again. or you imply a persons salary should be directly related to the stability of the industry in which he/she works. this is not true.

            “And, higher asset prices contributed to the high level of consumption and borrowing in the disinflationary 1982-07 “long boom,” with declining interest rates.”
            higher income levels, particularly in the clinton days, lead to greater consumption. you need to explain how a disinflationary 25 year period led to asset price inflation.

            you are getting ahead of your college classes at this time, best to focus on the upcoming semester before returning to the comments.

          4. PeakTrader

            baffling, I have degrees in economics, a subject you continue to prove you don’t understand.

          5. baffling

            peak, the problem is you simply recite word for word what you were taught in class, but you are unable to adapt what you have learned in class to different boundary conditions which exist in the real world. it’s not your education that is lacking-it is your application of that education which is lacking at times. it is very common behavior with respect to recent graduates-they have all the answers already!

  14. Tom

    Many public pension funds across the country are heading for blow-ups, for the reasons you describe here plus the dirtier one of outright corruption. There’s a widespread practice of hedge and PE funds kicking back performance and management fees to associates of public pension fund managers, under the guise of finder commissions. Note that performance fees are paid even on unrealized gains.

    Note that gain/loss ratios are not equal, they are always skewed to the downside, and the more leverage, the bigger the skew. With no leverage the skew is only the transaction commission and/or spread. With leverage, if you’re using margin credit you pay financing costs and take the risk of margin call, or if you’re using derivatives you face much bigger spreads plus a very skewed win/loss ratio built into the derivative’s price behavior.

  15. Jfh

    Does anyone else see the irony? The Wisconsin pension fund is 99.9% funded, and is the best in the nation. Yet, on a regular basis, Dr. Chinn unloads on the state politicians who safeguard the stability of the fund (i.e. Governor Walker). Yet Dr. Chinn nicely benefits from the stability of the fund, and I really doubt that Dr. Chinn would want to exchange his Wisconsin Pension Benefits for California Pension Benefits. The other half of this blog (Dr. Hamilton) lives in California, where pension promises are much more uncertain, as evidenced by the above post. I just wonder if JHB doesn’t wish that his own state governor would adopt some of the financial responsibility of, say, Wisconsin (and Governor Walker), to fix the budgetary and political mess that is California politics, as that mess presumably leaves JHB’s own pension (if he gets one) on more shaky ground. But, I also suspect that JHB is too polite to say so.

    1. Nick G

      state politicians who safeguard the stability of the fund (i.e. Governor Walker

      Governor Walker has taken steps to protect pension funds? I’d be curious to see evidence/links for this.

    2. Menzie Chinn

      Jfh: No irony. I have a pension with the State of California, as a former University of California employee (Assistant, Associate, Full Professor, 1991-2005).

      Try again…

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