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?