Bernanke Teaches Again

 

When I first showed up at Princeton as an Assistant Professor, Ben Bernanke was teaching WWS 512b (Macroeconomics for the Master’s program at the Woodrow Wilson School of Public and International Affairs) and I was to teach WWS512c (same course, mathematical version).   As I figured out what and how to teach policy macroeconomics for master’s students, I leaned on Ben, who I quickly realized was an exceptionally clear teacher.  Professor Bernanke is now Chairman Bernanke, but he is back to teaching macroeconomics.  He is lecturing at GWU, but really for the world as the class is on-line here.  I highly endorse these lectures: Ben is a clear teacher with an intellectual (non-partisan) approach to central banking; he was an expert in banking crises and got the U.S. through this latest one; he not only believe in the benefits of central bank transparency, but has moved the Fed to being much more transparent in many dimensions.

 

The Role of the Office of Financial Research

 

Here, in a readable but general document, is the Office of Financial Research’s strategic plan.

A huge amount depends on the talent that it can draw and the culture it can develop.

Did I, an economist, really say that about culture?  Huh. I guess it shows how little we know about what makes for an (in)effective regulatory agency.

Termination vs Ongoing Approach for Pension Solvency Dates

In light of the recent GAO report, one question I have received is how public pension solvency dates would change if one assumes an “Ongoing” model instead of a “Termination” model. The Termination approach asks how long existing assets would last to cover liabilities that have already been promised. It assumes that future contributions will cover the cost of future benefit promises and will not be wiped out to fund legacy promises. This is the approach I took in a paper from 2010 that examined exhaustion dates. An Ongoing approach instead assumes that future contributions are available to make payments at the time and could be completely wiped out if necessary to pay legacy liabilities. Note that in many systems departing employees can ask for contribution refunds, so that it is not clear that all future employee contributions are fully available for legacy promises.

Fortunately, Alicia Munnell and coauthors have already analyzed and answered this question in the 2011 paper “Public Pension Funding In Practice,” Journal of Pension Economics and Finance 10: 247-268. The main table from Professor Munnell’s paper is as follows. It shows that under the Termination framework public pension plans nationwide have assets through 2025 assuming 8% returns and 2022 assuming 6% returns. Allowing future contributions to be wiped out to pay for legacy liabilities extends the solvency horizon on average by 4-5 years.

Another interesting graph from the paper is the following, constructed under the 8% return scenario.

It is interesting that even under the Ongoing framework, assets of more than half the plans (7%+29%+33%) are exhausted by 2029, 36% (7%+29%) are exhausted by 2024, and 7% are exhausted before 2020.

At the time of the Munnell study, assets in the sample plans were $2.7 trillion as of 2009, according to the study.  As of the last high-water mark for the stock market (June 2011), total state and local government retirement assets stood at $3.0 trillion according to the Fed Flow of Funds, which also corroborates the 2009 figure. It is telling that even a very strong market in which stocks have returned approximately 10% annually since 2009 have had such a relatively small effect on the situation.

Closing the US Deficit

The Administration produced its 2012 Economic Report of the President recently.  These reports are written by the economists at the Council of Economic Advisers and tend to employ solid economic arguments and use data correctly – not always and everywhere, but very well by Washington Think Tank standards.  The Chapter in this year’s Report entitled “Restoring Fiscal Responsibility” is a nice read in that it sets out the challenges and give some ideas as to how the Administration plans to address our fiscal imbalances.  The chapter is here.

The Greek Debt Timeline and Control Rights

The details of the write-down of Greek debt are set, or at least set conditionally, it will be very interesting to watch how the markets respond.  On the details, this figure sets out the timeline and how market/debt-holder participation influences the process.

After all this time and European money, a flat out default is still quite possible.   And it is also interesting to note that the structure has not solved the free-rider problem or the CDS problem.  Some debt holders may not accept the terms of the restructuring in the hope that others will be restructured and they will be paid in full.  This problem may bring the whole structure crashing down.  Some investors may have debt which is written down by more than appropriate for its term (e.g. long-term debt holders taking very severe write-downs or short term debt holders taking even modest write-downs).  The CDS problem is that insurance creates moral hazard.  The decision-maker for any given debt instrument may not have an interest in maximizing the payoff of the debt and may instead prefer full default or a differently structured write-down (or even be over-insured and benefit from a complete default).

Pensions in MuniLand

Cate Long, the MuniLand blogger from Reuters, wrote a blog post yesterday that misses the entire point about pensions and spreads gross misunderstanding about the cost of pension promises to taxpayers. The risky assets that pension funds invest in and the returns they have achieved historically have nothing to do with the cost of making these promises. The reason pension promises should be discounted at a default-free rate such as the Treasury rate is that governments are telling public employees that they will get their pensions no matter what happens to the pension funds’ risky investments in stocks and alternative assets.

Certainly if Ms. Long wants to credit state and local governments for their option to default on these promises in the event that asset returns are poor, then a higher discount rate than a default-free rate could be used. But then the contracts with public employees should specify that in fact they may only be paid a fraction of what they are owed and the discount rates should be motivated accordingly, not with historical asset returns.

For deeper analysis, I would refer readers to my paper The Liabilities and Risks of State-Sponsored Pension Plans with Robert Novy-Marx and my Congressional testimony of February 2011.

Finally, the piece by Ms. Long also refers to a statistic that approximately three percent of state and local government spending is used to fund pension benefits for employees of state and local governments. As I have blogged about before, this is very misleading. First, many governments are not making contributions they ought to be even under their own accounting. Under correct default-free measures essentially no government is contributing enough to claim they are truly paying pension costs. Second, the figure cited as a fraction of spending, not revenues. Since states are running deficits, as a share of revenues, pension contributions are higher. Finally, the denominator includes the hundreds of billions of state and local revenues that are direct transfers from the federal government. The right question is not how much is being paid now, but how much would have to be paid in order to claim that states are balancing their budgets. That figure is substantially higher, and amounts to 14% of total revenue excluding federal transfers and 23% of tax revenues.

Volcker on Volcker

 

Ex-Fed Chair Paul Volcker has weighed in again with a nice piece for the SEC that defends the rule bearing his name.  The Volcker rule, part of Dodd-Frank, bans proprietary trading by investment banks (and others whose primary role is systemically important and not based on trading) —  the loose version of the rule is rule is “take the casino out of the bank.”  Here is his defense.  The difficulty is measuring proprietary trading – it is not trivial to separate gambling from hedging and even (at least banks claim) from trading on behalf of clients.

 

 

Wiggling Out of Registering

Following Dodd-Frank legislation, the SEC is going to require private equity fund advisers to register with the SEC, which broadens the registration requirements that currently apply to financial advisers   Several members of Congress are complaining (see their letter here) and asking the SEC to not require registration by advisers to funds that are not highly leveraged.  They argue that the typical private equity fund investor is “highly sophisticated” and making illiquid investments.  My response: sure, the typical one is. I expect the typical adviser-investor relationship is not a concern.  That does not mean that we do not want to keep track and be able to find the relationships/advisers that are problematic.  The other argument is that private equity does not post systemic risk issues.  This is silly.  As the letter notes “private equity has a key role to play in our economic recovery.”  A hit to the equity in private equity firms could easily be a systemic problem, like a hit to the equity of investment banks. Finally, the issue of leverage seems misguided.  A fund can use zero leverage, but by holding equity in a venture with a lot debt, it is in effect leveraged.  The exemption could incentivize funds to be less levered and individual start-ups or private firms to become more levered.  And the SEC could not track advisers who advised funds that invested in highly levered private firms.  The big question: why the big fuss?  Who is it that is trying to keep this information out of the SEC and out of the market?

 

Lending in times of financial crisis: the ECB and the Fed

When the financial crisis came, central banks followed Baghot’s rule: in a financial panic, lend freely against good collateral. It turns out that the US Federal Reserve did this well, in that it is making profits for the US taxpayer and not losing money. (One interpretation, they are earning returns for bearing risk which is another way of saying they were lucky; the other interpretation, they were savvy and profited from providing liquidity when it was scarce.) The New York Times has a piece today noting both how profitable the Fed is and how similar to a hedge fund except for the compensation of its employees. Two differences the article glosses over are the advantage of the Fed — it always can have access to liquidity so can take illiquid positions — and the fact that most hedge funds are quite unprofitable lately (after fees). In contrast, the ECB seems to have lent against bad collateral (article here). It looks like the collateral it received from Lehman did not cover the value of the loan, although it will be close if one thinks of a billion dollars as close and one ignores the costs of asset management. Of course, the US Federeal Reserve in part did so well because the US Treasury took first losses on many loans.

The Effects of Being in the Eurozone on the Rating of Sovereign Debt

Here is a nice short piece by Martin Feldstein explaining the error in the argument made by some French politicians – including the head of the French central bank — that UK sovereign debt should be downgraded before French sovereign debt.  In short, it seems they do not understand what it means to be in a monetary union.  The piece could emphasize more that while France is at a greater danger of default, inflation is also a pernicious destroyer of investor returns on debt, just not one covered by bond ratings.