Any official who wants to understand the terrible state of American public-sector pensions should read the financial report of the Illinois Teachers Pension Fund. Its funding ratio of 40.7% is one of the worst in America, according to the Centre for Retirement Research (CRR) in Boston.
Since it was established in 1939, Illinois officials
have not once set aside enough money to fund the pension promises made. As a
result, three-quarters of the money the state (or rather the taxpayer) now pays
in each year merely covers shortfalls from previous years. The situation is
getting worse. In 2009 the schemes’ actuaries requested $2.1bn, but only $1.6bn
was paid. By 2018 the state paid in $4.2bn, still well short of the $7.1bn the
actuaries asked for. The trustees have warned that the plan would be “unable to
absorb any financial shocks created by a sustained downturn in the markets”.
Other schemes have attracted similarly stark
warnings. Illinois is the class dunce, with six languishing schemes.
Offering workers a defined-benefit pension, where an
income based on final salary is paid for the rest of their lives, is an
expensive proposition, especially as life expectancies lengthen. Pension
shortfalls are common across America, with the average public scheme monitored
by the CRR just 72.4% funded. That adds up to a collective shortfall
of more than $1.6trn.
When a scheme is underfunded, one of three things can
happen. More contributions can be made, by employers or workers or both.
Benefits can be cut. Or the scheme can earn a higher return on its investments
to make up for the shortfall.
Cities and states are paying more, but still not enough. In 2001 public-sector employers contributed a further 5.3% of their payroll to meet pension promises; now that figure is around 16.5% on average. Even so, in no year since 2001 has the average employer contributed as much as demanded by actuaries. Last year’s shortfall was just under 1% of payroll.
This reluctance is understandable. Politicians
dislike raising taxes—or cutting services to pay for higher contributions.
Workers do not want to see their current pay reduced by higher deductions, or
their future benefits cut. And in any case, in some states courts have ruled
that pension benefits, once promised, cannot be taken away.
So states and cities have crossed their fingers and
hoped that their investments will bail them out. America’s buoyant stockmarket
has done its best to help. Returns on government bonds have also been good for
much of the past three decades. Even so, the average public-sector scheme is
less well funded now than it was in 2001.
Such severely underfunded schemes risk entering two
vicious circles. The first involves costs. Kentucky’s public pension scheme
covers a wide range of state employers and some have to pay 85% of payroll to
cover their pension obligations. Employing someone on $50,000 a year requires
an extra $42,500 of contributions. They naturally seek to lay off workers to
reduce this cost. But that leaves fewer people paying in without changing the
number currently receiving retirement benefits. That increases the short-term
The second concerns the accounting treatment of
public-sector funds. Many assume nominal returns on their portfolios of 7% or
more after fees. This optimism has a big impact.
These calculations look surreal by comparison with
private-sector pension funds. Their accounting rules regard a pension promise
as a debt like any other. After all, courts insist pensions have to be paid,
whatever the investment returns. The discount rate must therefore be based on
the cost of debt—for companies, the yield on AA-rated corporate bonds.
Since that yield, now around 3%, is far lower than the return assumed by
public-sector funds, private-sector pension liabilities are very expensive.
Faced with a $22.4bn shortfall, General Electric recently froze pension
benefits for 20,000 employees.
These different accounting approaches seem to imply
that it is cheaper to fund a public-sector pension than a private-sector one.
In reality, that cannot be the case. The public-sector pension deficit is
therefore much larger than the $1.6trn estimated by the CRR.
This is a crisis no one wants to solve, at least not
quickly. The Chicago Teachers scheme is aiming for 90% funding, but not until
2059—long after many retired members will have died. New Jersey’s teachers’
scheme is not scheduled to be fully funded until 2048. Such promises might as
well be dated “the 12th of never”. The bill for taxpayers seems certain to rise
substantially. For the states with the biggest pension holes, political
conflict is in store.
“Didi Chuxing may have defeated Uber, but China’s dominant ride-hailing platform is no match for the country’s local governments after being forced to gut its urban fleet to comply with regulations.”
“Didi is the world’s fourth-biggest private tech group with a $34bn valuation last September. It has raised more than $10bn from investors including Apple, who invested $1bn in the company last year.”
But… there is the issue of recent regulation from Beijing and Shanghai: “local cars, local drivers.” Issue is that the majority of Didi’s drivers and especially the vast majority of its low paid drivers were migrants.
We’ve seen the model. Didi and Uber rely on marginalizing it’s drivers or losing its investor’s money, hence the push for autonomous cars to reduce its labor costs.
As the company put it “because our transportation capacity has been reduced recently, there may be some impact…on the chances of successfully hailing a ride and on waiting times, which Didi apologizes for.”
“Shaun Rein of China Market Research Group said: ‘The new measures have a serious impact on Didi’s business. It threatens their ability to grow because it’s hard to find drivers.'”
Hence, “in February Didi announced it was moving into high-end car-hailing services, a consequence of losing its pricing advantage against taxis.”
“Analysts say that the company has no choice but to go upmarket and look for other sources of growth.”
And of course, they have to be mindful that other cities are likely to implement similar regulations.
“Didi’s new direction is also likely to bring it into closer co-operation with the traditional taxi companies it once competed with, and even take it back to its roots as a taxi-hiring platform.”
“India’s ‘sand mafia’ is doing a roaring trade. The Times of India estimates that the illicit market for sand is worth around 150bn rupees ($2.3bn) a year; at one site in Tamil Nadu alone, 50,000 lorryloads [truck loads] are mined every day and smuggled to nearby states. Gangs around the country frequently turn to violence as they vie to continue cashing in on a building boom.”
“Most of the modern global economy depends on sand. Most of it pours into the construction industry, where it is used to make concrete and asphalt. A smaller quantity of fine-grade sand is used to produce glass and electronics, and, particularly in America, to extract oil from shale in the fracking industry. No wonder, then, that sand and gravel are the most extracted materials in the world. A 2014 report by the United Nations Environmental Program (UNEP) estimates they account for up to 85% by weight of everything mined globally each year.”
“…Of the 13.7bn tons of sand mined worldwide for construction last year, 70% was used in Asia. Half was used in China alone, where the government estimates that it built 32.3m houses and 4.5m km (2.8m miles) of road between 2011 and 2015.”
“Sand often makes up the very ground that is built on, too. By virtue of dumping vast quantities of sand into the sea, Singapore is now over 20% larger than it was when it became independent in 1965.”
Thing is “sand may appear plentiful, but is in fact become scarce. Not all types are useful: desert sand is too fine for most commercial purposes (Qatar is a big importer and the Burj Khalifa skyscraper in Dubai was built using Australian imports). Reserves also need to be located near construction sites; as transportation costs are high compared with the price…”
“Substitutes for sand do exist. Mud can be used for reclamation, straw and wood to build houses, and crushed rock to make concrete. Asphalt and concrete can be recycled. Production processes will shift towards these alternatives as the price of sand rises…”
Further, select countries are seeking to do their part. “Reduced demand from Singapore might discourage illegal mining in nearby countries. Rising prices will eventually force developing-country builders to explore alternatives to sand. But without better law enforcement, high sand prices also make illicit mining more lucrative. Despite the damaging consequences, the sand mafia will continue raking it in for a while.”
WSJ – Daily Shot: Employment in video-tape and DVD rental stores 3/30
“American companies are trying to stop employees from raiding their 401(k)s, in an attempt to ensure that older workers can afford to retire and make room for younger, less-expensive hires.”
“Tapping or pocketing retirement funds early, known in the industry as leakage, threatens to reduce the wealth in U.S. retirement accounts by about 25% when the lost annual savings are compounded over 30 years, according to an analysis by economists at Boston College’s Center for Retirement Research.”
“‘Employers have done a lot to encourage people to save in 401(k) plans, such as automatically enrolling them. But there is a growing recognition that if the money isn’t staying in the system, the objective of helping employees reach their retirement goals isn’t being met,’ says Lori Lucas, defined-contribution practice leader at investment-consulting firm Callan Associates Inc.”
“Employees who grew accustomed to borrowing from their 401(k)s during the recession are tempted by the rising balances in these types of plans, which currently hold $7 trillion, up from $4.2 trillion in 2009, experts say.”
Further, when employees change jobs there is the temptation not to rollover their 401(k) balances.
“On average, about 30% to 40% of people leaving jobs to elect to cash out their accounts and pay taxes and often penalties rather than leave the money or transfer it to another tax-advantaged retirement plan, according to recordkeepers and economists.”
“Most plans also allow people to pull out their savings-after paying taxes and typically a penalty-for reasons including buying a home, preventing foreclosure, and paying medical bills and college expenses, something relatively few participants do annually. These are known as hardship distributions and the employee must demonstrate an ‘immediate and heavy financial need,’ according to the Internal Revenue Service.”
“Employees can also generally choose to borrow up to half of their 401(k) balance or $50,000, whichever is less, without having to state a reason. According to the Employee Benefit Research Institute, a nonprofit research group, 87% of participants are in plans that let them take 401(k) loans.”
“About a fifth of 401(k) participants with access to 401(k) loans take them, according to the Investment Company Institute, a mutual-fund industry trade group. While most 401(k) borrowers repay themselves with interest, about 10% default on about $5 billion a year, says Olivia Mitchell, an economist at the University of Pennsylvania’s Wharton School.”
“‘4019(k) plan leakage amounts to a worryingly large sum of money that threatens to undermine retirement security,’ says Jake Spiegel, senior research analyst at research firm Morningstar Inc. His calculations show that employees pulled $68 billion from their 401(k) accounts taking loans and cashing out when changing jobs in 2013, up from $36 billion they withdrew in 2004.”
“Australia’s house prices are rising at their fastest pace in seven years, igniting fears of an emerging property bubble and prompting regulators to crack down on risky bank lending.”
“New figures on Monday show residential property prices have increased 12.9% in the past 12 months, with prices in Sydney surging 18.9% – the fastest rate of growth in almost 15 years.”
“House prices in Sydney have more than doubled since the financial crisis hit in January 2009 while prices in Melbourne are up 92.4%. This has occurred despite sluggish consumer price inflation, tepid rates of business investment and economic growth.”
“Surging house prices are a concern for global regulators as they seek to prevent the asset price bubbles in an ear of ultra-low interest rates ushered in by the financial crisis in 2008. Regulators in Australia, Ireland, New Zealand and a host of other countries have introduced macroprudential rules in a bid to slow house price inflation.”
“In 2014 Australian regulators placed a 10% limit on growth in new lending to investors, a move that initially slowed bank lending to the buy-to-let sector. But a recent increase in lending to investors prompted regulators on Friday to issue new rules limiting the flow of ‘interest only’ mortgage lending by banks to 30% of new loans issued.”
“About 40% of new mortgages are issued on ‘interest only’ terms, under which borrowers do not have to pay back the principal of the loan for a specific period.”
“The regulator also placed limits on the volume of ‘interest only’ lending at loan-to-value ratios above 80% and flagged closer scrutiny of lending at loan-to-value ratios above 90%.”
More importantly, economists are pointing to the Australian tax system that needs some reform. Specifically “Australia’s system of ‘negative gearing’ provides investors with a tax break allowing them to claim as losses the financing and other costs of their rental properties against other income. The tax break has become so popular that 15% of the electorate have become buy-to-let investors.”
“Investor loans make up just over one-third of the A$1.49tn (US$1.13tn) residential property market, according to Australia’s prudential regulator.”
Reminds of me of the U.S. tax system before the Tax Reform Act of 1986 – when professionals of all sorts would invest in real estate simply for the sake of the tax write-off. If the property made money or went up, all the better. Easy to see how valuations can become disconnected from their fundamentals. Alternative truths and some hard facts about coal. Nick Butler. Financial Times. 2 Apr. 2017.
“The share of electricity production in the UK accounted for by coal fell to just 3.5% in the third quarter of 2016.”
“Worldwide, the number of new coal-fired power stations starting construction fell by over 60% in 2016.”
“Over-supply has pushed thermal coal prices down to half the level reached in 2010.”
At the same time
“Some 42,000MW of new coal-fired generating capacity was brought on stream in China last year and Beijing announced that coal consumption was set to rise by 19% over the next five years, despite rapid growth in the use of renewable sources.”
“In spite of extensive subsidies for renewables, 40% of electricity in Germany last year came from coal, leading to an increase in carbon emissions in 2016.”
“Across the world 50% of aluminum, 70% of steel and 40% of electricity are produced from coal.”
In the UK, regulation is systematically phasing out coal energy. In Germany, there is enough political support from the Social Democratic party to keep coal use going.
“In the US, the main threat to coal is not environmental regulation but price competition from low-cost natural gas. Coal is the principal victim of the shale gas revolution and the revival of the shale industry will intensify that competitive challenge over the next decade.”
“China is the world’s largest user of coal (burning more than 50% of the global total) and is pursuing a serious policy of encouraging renewables and setting a ceiling on coal demand growth.”
“The biggest challenge and the most important factor in the global coal market is India.” While the country is serious about renewable energy initiatives, the country wants economic growth. “The problem is that to grow, it needs the cheapest possible form of power on a large scale and for the moment that is coal. Nuclear, solar and wind will all contribute but coal is the pre-eminent source of supply and Indian imports will shape the world market.”
“Coal is plentiful and cheap and will be made cheaper still if US producers, under pressure from gas in their domestic market, export more.”
“Until the new sources of energy supply can beat the current low prices coal will remain the leading source of heat and power and will meet something like a third of the world’s energy needs. The proportion burnt in high efficiency, low emission plants will rise but that will remain a fraction of the total for the foreseeable future, not least because coal users cannot afford the upgrades necessary. Coal is the energy source of choice, through necessity, of the poorer half of the world.”
“Times may be tough for the industry, and the continued use of coal in sub-critical technology may be bad for the environment, but like it or not coal is not in free fall.”
WSJ – China Capital Outflows Bubbles Below the Surface 9/20. “China’s outflows this year are north of $400bn, which is reflected both in a $190bn decline in the country’s foreign-exchange reserves and a weaker yuan, down about 3% this year against the dollar and more than 6% against a basket of currencies.”
A recent study that was published in Environmental Research Letters, a top academic journal, indicated that the “toxic haze that spread across Southeast Asia from Indonesia forest fires last year caused the deaths of about 100,000 people across the region.”
“The death toll was concentrated in Indonesia, which had about 92,000 excess deaths from persistent haze that choked the region between July and October, according to researchers at Harvard and Columbia.”
“What the BIS (Bank for International Settlements) terms the country’s ‘credit gap’ is now three times higher than the typical danger level, the research shows.”
“The BIS rates a reading above 10% as cause for concern; China’s gap hit 30.1% in March.”
“The International Monetary Fund estimated in June that Chinese companies that had borrowed a collective $1.3tn did not have enough earnings before interest, taxes, depreciation and amortization to meet interest payments.”
“China first breached the 10% threshold in 2009 and has not yet experienced a crisis. Many analysts believe that the country’s low level of foreign currency debt and its government-controlled banking system make crisis less likely.”
“China Debt Default? To alleviate its debt problem, China should adopt appropriate macro-economic policies encompassing currency depreciation and cutting interest rates to an ultra-low-level within two to three years, believe Nomura analysts. Yang Zhao and team said in their September 14 research piece titled “China: Solving the debt problem” that they believe RMB depreciation will continue and forecast USD/CNH at 7.1 at the end of 2017.”
“Losses from bad debt in China’s shadow financing sector could amount to 3.7% of GDP, according to a new analysis of off-the-books lending and investment.”
“The new report from CLSA also estimates shadow financing in China grew to Rmb54tn ($8.1tn) by the end of 2015 – equivalent to 79% of gross domestic product, with 64% of the total originating at or relating to mainland banks.”
“The firm also reiterated its May estimate for Chinese banks’ non-performing loan ratio of 15%, or Rmb11.4tn, assuming the same recovery ratio of 40%, which would entail potential losses of 10% of GDP. The total losses when combined with those from bad debt in shadow financing would come to 13.7% of GDP.”
“The Japanese central bank, which has struggled for nearly two decades to bring about steady inflation, said Wednesday it wants to keep the yield on 10-year Japanese government bonds at zero, and will adjust the pace of its bond buying as needed to achieve that.”
“The long-term-rate target, the first in the BOJ’s century long history, challenged conventional wisdom that rates in the huge government-bond market are ultimately set by market forces and can’t be fully controlled by an official entity. Central banks are usually assumed to have much more control over short-term rates, and many around the world target rates for debt with a term of less than a year.”
“One worry: ‘In theory, they could be forced to buy an unlimited amount of bonds,’ said Marcel Thieliant, Japan economist at research firm Capital Economics in Singapore.”
“Mr. Kuroda called the new policy a ‘reinforcement’ of easing. The BOJ also took the unexpected step of saying it would aim for inflation to exceed 2% instead of merely hitting it, a nod to calls from some U.S. economists for a higher target.”
“The universe of negative-yielding sovereign debt fell to $10.9tn as of September 12, a drop of $1tn since June 27 largely due to yields on some longer-dated maturities moving back into positive territory, according to a new report from Fitch Ratings.”
“Of the countries afflicted by negative yields, Switzerland has 95% of its outstanding debt trading with a yield below zero.”
“Fitch also calculates that as a result of low and negative yields, investment income for sovereign investors globally are ‘prospectively earning nearly $500 billion less annually in investment income than they would have earned with yields available in 2011.’ The investment-grade sovereign debt market is $38bn.”
“No, I do not think China is going to massively implode, but the world is really not ready for a China that is only growing at 2% or 3% a year. (Even though 2-3% growth would sound pretty good if it was happening in the US.)”
“A total of 41 default cases have hit China’s domestic debt markets in the year to mid-September, more than the previous two years combined, according to Wind Information, a Shanghai-based financial data company. Some 70% of defaults by end-July were by state-owned enterprises, according to IHS, a consultancy.”
“The big picture behind China’s local government debt problem is stark. The liabilities of well over 100,000 companies problem is stark. The liabilities of well over 100,000 companies owned by local governments across the country grew at an average annual rate of 14.1% from 2012 to 2015 to reach Rmb35.4tn ($5.3tn), according to Moody’s research.”
“These are treated as contingent liabilities – or potential liabilities – because although local governments do not guarantee the debts of their corporate subsidiaries, they nevertheless are responsible for generating local economic growth, employment and public services so they would be loath to let an important contributor to such goals go under.”
“But in recent years, some local governments have built up such hefty debt burdens that even if they would like to bail out an important local employer, they may not be able to. Total direct local government debt, according to Moody’s, was Rmb16tn in 2015. Thus direct and contingent liabilities come to Rmb51tn – more than the GDPs of Japan and Germany combined.”
As to which companies to let default… “Nicholas Zhu, vice-president at Moody’s, describes a clear hierarchy of debt vulnerability. The most likely to default would be lossmaking, indebted companies owned by lower-tier governments – at the prefectural, city or county level – that have little revenue and large debts. The problem, however, with lower-tier administrations is that they often publish sparse statistics, so it is difficult to know the true state of their financial health.”
“Nomura, which estimates China’s total debt – government and corporate debt – is Rmb211.8 trillion or 309% of GDP. The vast majority of this debt is corporate, which from a leverage perspective looks better. Non-financial sector accounted for Rmb158.5tn (231% of GDP, up by 92pp from 2007) and the financial sector for Rmb53.3tn (78% of GDP, up by 49pp).”
“The debt is up nearly 141% since 2007, which leads Nomura to conclude “a rising default rate is inevitable.”
“What this all means is that interest rates are likely to head near zero – the place at which such defaults can find their most advantageous environments. And of course, when interest rates fall, so, too, does the currency values. In the end, it is likely to become one big mess that might have global implications.”
“The number are severe. According to the National Institute on Retirement Security, nearly 40m working-age households – 45% of the total – had no retirement savings whatsoever in 2013, whether an employer-sponsored 401(k) plan or an individual retirement account (IRA).”
“If you look for the black hole in the pension system, this is it. And these are the most vulnerable people in society.” – David Hunt, chief executive of PGIM, Prudential Financial’s asset management arm.
“Indeed, while younger people are less likely to have some sort of a retirement nest egg than older Americans, the biggest factor is income. Households with a retirement account have a median income of $86,235, while those without one have a median income of $35,509, according to the NIRS.”
“We have a crisis unfolding here. We’re asking people to set aside precious resources they don’t have… For millions and millions of Americans, the only thing they’ll have is Social Security.” – Russ Kamp, a pensions consultant
Social Security “together with the Supplemental Security Income program account for over 90% of the income for the bottom quarter of retirees, according to the NIRS.”
“But Social Security’s future is as uncertain as it is politically divisive. When it was set up, retirees would only have to be supported for less than 13 years on average. These days the average American can expect to draw Social Security for almost two decades, and unlike traditional public sector pension plans, it operates on a pay-as-you-go basis.”
“Citi estimated earlier this year that the unfunded liabilities were over $10tn.”