Another Financial Time Bomb: Corporate And Public Sector Pensions Are Based On Absurdly Optimistic Assumptions
By Edward Chancellor at Breaking Views
DavidStockmansContracorner.com
April 18, 2016
The United States is not a “bubble economy”. That’s the official view of the Federal Reserve expressed by Chair Janet Yellen earlier this month. Yellen describes a bubble as a combination of “clearly overvalued” asset prices, strong credit growth and rising leverage. In other words, the type of financial fragility the central bank, with its vast research staff, failed to spot prior to the subprime crisis.
The Fed’s definition of a bubble is too narrow. Bubbles are, in essence, illusions of wealth. The last two great bubbles – internet stocks and U.S. real estate – involved inflated asset prices. The great current bubble is centered around liabilities, or promises to make future cash payments. The owners of these claims consider them part of their current wealth. But what if they cannot be paid?
These thoughts are provoked by a gloomy note on pensions by Andy Lees of the independent research outfit MacroStrategy Partnership. Lees is worried that the assumptions involved in calculating pensions are as flawed as the valuations prevalent during the dot-com bubble.
The present value of a pension is arrived at by discounting future cash payments. As interest rates have fallen, this discount rate has declined, increasing pension liabilities. As a result, many pensions find their liabilities exceed assets. In pensions-speak, they are “underfunded”.
For instance, the current deficits of U.S. corporate “defined benefit” pension plans are estimated at around $425 billion, by Citigroup. UK and European corporate pension plans also sport large deficits. The aggregate shortfall of American public-sector pension plans – state and local government – is somewhere between $1 trillion and $3 trillion, according to Citi.
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