Monday, March 19, 2012

The US economy gave a good account of itself for the fourth quarter 2011 and the stats from that period are reflected in the current stock market. In the first quarter of 2012 the economy has clearly slowed or flattened out. The rising oil price based on uncertainty in the Middle East is causing the economic pause. I think this is a good thing. The longer and slower the economic recovery is the better we will be in the long run. We have structural problems and these need to be addressed. I believe the current administration was right to push a large stimulus bill early in 2009, without which we would not have an economy to discuss. I believe the opposition is right to resist further federal spending because it is not needed and the private sector needs time to work. Clearly the stimulus spending exacerbated the deficit and now that the economy is recovering we should address the deficit issue. I believe and have said many times both sides of the issue must be used to solve the problem i.e. lower spending and higher taxes. Anyone not willing to use both options is not serious about solving the deficit problem.

The above issues are coming together at the state and local level. Since 2007-2008 we have a blue print for financial institutions and what to do if they are insolvent. We do not have a similar plan for state and local governments if they become insolvent. The benefits promised to public employees are too large and are accruing at too rapid a pace. I believe before the final chapter is written the public will realize that not only should new employees not be under the same system but we cannot afford to pay the benefits already promised to retirees.  I don't think the math points any other way. As the public begins to realize just how much funding is necessary to get even with the benefits already promised I expect a rancorous public debate. We can't chase our tail forever on this issue. We, as a country need to think of broad solutions and ask the big questions. Why do public employees have pensions and not 401(k)'s and IRAs? If your life expectancy is longer should your retirement age be raised? If the state of NY pays for your medical insurance shouldn't you be required to be treated in NY?

It is going to be an interesting process, stayed tuned.

Monday, March 5, 2012

The Federal Reserve has kept interest rates at an all time low for years now. This fiscal policy is in response to the banking crises of 2008 and is an acceptable policy to try to stimulate the economy. This is a two edged sword like many policy choices. On one hand, the interest component of US Government debt is very low which is helping to contain deficits. On the other hand, any entity with a defined benefits pension plan will suffer because they need a certain level of return to make their plan work. It is acceptable for these plans to predict a certain level of return and base their contributions on these assumptions. What has happened over the last few years is that the level of return in the fixed income portion of the portfolio has been less than anticipated. The low returns are causing a shortfall which must be made up by increased contributions. This is true for GE and major corporations as well as states and municipalities.Last week a number of companies acknowledged this problem. Unfortunately the state governments which a year ago seemed like they were willing to face this issue are backsliding. California, where the legislature is unwilling to deal with the issue and NJ where the governor has suddenly resorted to pie in the sky assumptions are the most obvious examples. Make no mistake this issue is widespread, significant and still getting worse.

The Greek bail out will come to a head this week. In the next few days private investors will either agree to accept a voluntary haircut on their Greek bonds or not. Without 75% participation the deal will fail, Greece will default and the Credit Default swaps will be triggered. I have to believe that more than 25% of the Greek bondholders have some sort of credit protection and will not opt for a voluntary solution, which will cause a default. I believe this is priced into the market already.

Question of the week: Why is Mary Shapiro still head of the SEC?