Submitted by Thad Beversdorf via FirstRebuttal.com,
I happened to be going through the Red Cross audited financials this morning (this is not typical morning reading for me but I’m doing some due diligence on another matter). Under the Notes to Financials I came across the organization’s pension assets breakdown and what I found was a bit shocking.
More than half of the organization’s pension assets are level 3 assets. For those not up to speed on the level 3 assets here is the definition from Wikinvest.
“Financial assets and liabilities whose values are based on prices or valuation techniques that require inputs that are both unobservable and significant to the overall fair value measurement. These inputs reflect management’s own assumptions about the assumptions a market participant would use in pricing the asset or liability (examples include certain private equity investments, certain residential and commercial mortgage related assets (including loans, securities and derivatives), and long-dated or complex derivatives including certain foreign stock exchanges, foreign options and long dated options on gas and power). Level 3 assets trade infrequently, as a result there are not many reliable market prices for them. Valuations of these assets are typically based on management assumptions or expectations.”
Now I’m not an expert in ERISA regulations but I was surprised to see this allocation mix for the Red Cross pension assets. My (limited) understanding is there are fairly strict guidelines and limitations on what portion of overall assets can be allocated to high risk investments; level 3 assets representing the highest risk on the risk continuum. However, as a portfolio manager one is under pressure to generate sufficient yield to sustain cash outflows (obligations) of the pension. While historically PM’s could achieve 7% returns with quality corporate paper and Treasuries, today that is simply a pipe dream. Currently the US 10 yr is at all time lows and has continued to decline since 2007, now yielding around 1.8%. As interest rates declined from 2007 we can see the allocation shift from safe to risky assets by the Red Cross pension.
Between 2007 and 2008 the Red Cross pension went from 14% of assets allocated to level 3 assets (nonmarketable & MBS) up to 28%. By June 2009 they had lost 25% of total assets, which meant they had 75% of the assets to generate the same obligations but with interest moving to 0%. The end result is the chase for yield with 53% of assets today being allocated to level 3 assets. Why? Because the obligations of the pension are essentially fixed but the returns are floating with Fed policy deteriorating risk adjusted returns. And so it’s not really a matter of choice but a mathematical necessity for the PM’s managing the pension to look toward riskier assets for that same 7% return.
And so we see how the Fed policies are directly responsible for ballooning the systemic risk in the financial and socioeconomic landscape. Not just pensions but actual individual retirees are facing the very same dilemma. That is, the cost to live is not something most have much control over. And so because retirees had baked in a 5% to 7% return on their nest egg they must achieve that annual return. This means for those lucky enough to still have a nest egg after the last two bubble crashes they are forced to venture further out onto the risk continuum. Risk adjusted returns have deteriorated into negative territory in Europe (it’s the only way an investor would accept a loss going into an investment i.e. negative rates) and we are very close to that here in the US. But there must be some upside to the ZIRP policies to offset the almost unmanageable amount of resultant risk, right? I mean these policies are meant to help the average American not hurt them, correct??
The above chart actually shows a decline in weekly earnings of the American worker.
The next chart, however, shows just where the policies’ upside landed.
Banks benefited most with 400% growth in income, followed by nonfinancial corporations with 280% growth in income but again with no benefit to the American working class incomes. So while risk to the entire system has ballooned by way of forcing pensioners (and all savers) to chase yield into the darkness as a result of the Fed’s policies over the past 8 years there has been absolutely no benefit to the American worker. However, banks and corporations have reaped significant rewards. And so I ask the PhD economists who have so gregariously supported the performance of the Fed for the past 8 years to explain just how these policies have helped the American people? And Zandi, stating you don’t believe the data is not an argument suitable to a PhD.