Personal Finance – Page 33

The Four Stages of Investment Knowledge

Posted on 21 June 200822 June 2008 by David Merkel

Alas, but we are poor creatures, muddling along in a confusing market that denies many the ability to earn money.? WHAT HAPPENED TO THE NINETIES, WHEN MAKING MONEY WAS AS EASY AS HITTING THE BROAD SIDE OF A BARN?!? Uh, that was then, this is now.? We’re in a dead spot, a lost decade; old certainties are being tested, and many clever investors (alas for Bill Miller) are being weighed in the scales and found wanting.

This is actually a good time to become an investor, because it is a bad environment.? You develop your skills when expectations are low, and the battle is tough.? But you have to confront the four stages of investment knowledge.

Stage one is being puzzled, and knowing that you don’t know much.? There is extreme caution and risk avoidance, and so much of the market appears to be random.? But with some drive, there is a desire to learn, and that leads to stage two.

A little knowledge is a dangerous thing.? It can come in the form of articles like “Ten Best Stocks to Buy Now!” or “The Simple Formula That Beats the Market, in One Tiny Book.” Whatever.? The initial knowledge is typically a stripped-down version of what has worked in the past, and past results indicate future performance.

Stage Three is the rare point, because it comes after some failure in stage two, because the world wasn’t as simple as the few experts initially read would indicate.? Stage three admits that the prior knowledge was very limited, and that investing is more complex than previously thought.? This is a time of study, and modest experimenting in investing, learning risk control, and understanding oneself.? What am I good at?? Where do I grasp value better than others?

Stage Four is where the survivors prosper in a limited way.? They know that the market is fickle, and have learned that their methods may be good in the long haul, but may underperform in the short run.? They don’t panic, they keep learning, and they persevere in times of fear and greed.? They invest as if it were a business, and are prepared for bad times, and don’t go crazy during good times.

My own methods are geared to Stage Four.? I’ve been through all manner of markets (minus the Great Depression), and know how badly I can be hurt.? I am ready for losses in the short run, if I know gains are likely in the longer term.? I’ve gotten to the point where losses on individual stocks don’t bother me; I just maximize value from where I am now, without letting past losses or gains prejudice me.

Investing is a business.? Spend time studying.?? Some of the book reviews on my site could be valuable in that respect.? Don’t let a few early losses get you down.? Investing is rewarding over the long haul; you can never tell when the game will get easier.? On a personal note, my worst time in investing was June-September 2002.? I lost big, but I did not lose confidence in my management methods, and made it all back and a lot more by the end of 2003.

Another way to say it is, “Be ready for losses.? Don’t let them knock you out of the game, but budget for them.? It is your market tuition.”? Ah, my market tuition.? Would that I could avoid the occasional “refresher course.”

Rethinking Comparable Worth

Posted on 21 June 200822 June 2008 by David Merkel

“Comparable Worth” was a faddish idea for economic leftists that flowered (thankfully it was brief) in the 1990s.? The idea was that you could measure occupations on a technical basis, measuring education, effort, responsibility, and other aspects of the job, and figure out what occupations should be compensated similarly.

That’s a pretty difficult problem to solve in the absence of markets.? Granted, there are some Human Resources (what a phrase) consulting firms that have models in narrow contexts to try to solve salary questions inside similar corporations, but the consultants true up their models to the markets regularly, and are covering a more narrow range of jobs.

I want to muse about a different kind of comparable worth this evening, one that many Americans (and others in “developed nations”) might not like.? It is my guess that we are seeing the slow erosion of wage differentials across developing and developed countries, particularly for goods and services that are part of global trade.

Now, I am not saying that an unskilled auto worker in China will earn as much as a non-union auto worker in the US, which is backed by more capital investment, and requires a smarter worker.? I am also not saying that unionized workers in developed countries won’t earn more.? The viability of the firms their unions serve may be compromised, though.? What I am saying is that global corporations can choose where they produce goods, and on a productivity- and quality-adjusted basis they will use laborers that give them the best deal.

As for jobs that are internal to an economy, such as working at a retail store, the adjustment will be slower.? Internal job wage differentials across countries depend on the overall wage differentials across countries.? As overall wage differentials narrow, so would internal job wage differentials.

Also, given how many commodities are priced globally, and those have become a more important part of the cost structure recently (though the effect is not that bad if one takes a long-term view… increased productivity means we use less commodities to achieve the same ends as 40 years ago), the factor share going to labor in developed countries is probably being squeezed a little.? So, what does this imply for workers in the US and the developed world?

As the rest of the world develops, their living standards will slowly converge with those in the US.? They will demand a greater share of the world’s resources in the process, making the affluent life more expensive.? This will in turn drive more technological innovation to make commodities stretch further.

Now, perhaps some will say that the solution is to cut off or limit free trade.? That won’t work.? The US is so dependent on free-ish trade that any significant reduction of trade would drive inflation up in the US.? Beyond that, the US benefits from its reserve currency status.? Where else does a country get goods and services, and hand over bonds denominated in their own currency?? What a sweet deal for the present — an inflationary pity when it ends.

I started out my career with a goal of being a development economist, and doing work in the Third World.? That ended when I learned that the models used by the development economists did not work, and that capitalism and free trade did work.? When the developing world began to make great strides after the end of the Cold War, I was happy.? I’m still happy about it today; poverty is slowly but steadily being eliminated across a wide swath of the globe, and that is a good thing for most.? But to many Americans (and others in develop nations) who are finding themselves out-competed by foreign competition, this is not a happy time.

Be aware of the global competitive position of your industry, and adjust your career accordingly.? Build up your own ability to deliver special (hard to duplicate) value for your employer and work where your personal competitive advantage is maximized.? That’s not easy, but the easy path probably embeds a future that is less well off.

Avoid Debt Unless it is to Purchase an Appreciating Asset

Posted on 18 June 200818 June 2008 by David Merkel

I’m generally against debt.? I’ve been debt-free for the past five years.? It allows me to take prudent risks with my investments.? So, when I read things like this in The Economist’s Free Exchange Blog, I shake my head.? Here’s the main quotation:

My friends who study humanities are shocked and do not believe me when I, a pension economist, tell them they should not be saving. Prudent advice has become: You should always save some fraction of your income. You should save not only for retirement, but also for adverse income shocks. But, Mr Becker points out, these new lines of credit help workers cope with income shocks.

The pension economist is wrong, mainly.? So is Dr. Becker.? It is reasonable to take on debt to gain an education for a career that is lucrative; it is not reasonable for something that does not pay well.? Following your heart into a career is a good thing, but if the field doesn’t pay well, don’t saddle yourself with debt to get there.? I know too many young people with large debts in their 20s with no reasonable way to pay them off.? They may be in the field that they love, but they are miserable due to the debt.

It is also reasonable to take on debt for an asset that will appreciate over time at a rate greater than the financing rate on the debt.? Note that I did not say housing here, though that is normally the case.

I counsel all of my kids, and all of my friends to avoid debt where it does not pay, particularly for consumption.? Pay off your credit cards in full each month.? If you can’t do that, cut up your credit cards, and learn to make do without them.

The advantage in life always comes to the man who has surplus, who receives a discount for paying upfront, rather than over time.? You should live below your means, and build up a buffer against the future.? Theoreticians like Dr. Becker essentially say, “Don’t worry, they’ll loan you the money.”? Ridiculous.? First, if they do loan, it is at horrendous rates.? Second, during a credit crunch, all cheap sources of financing disappear for all but the most creditworthy borrowers.? Credit disappears when you need it most.

Saving at young ages sets the tone for the rest of life.? The lifecycle saving hypothesis (of Milton Friedman) is wrong, because most people don’t possess the discipline to switch between being a borrower to being a saver.? Many do it, but not the majority. I saved money when I was a grad student, though most of my colleagues did not.

My advice to you is to develop careful spending habits, particularly if you are young.? What you do now will affect your ability to save for the rest of your life.? Borrow for things that have large long-term payoffs.? Delay purchases for short-term gratification.

Going BATS over Yahoo Finance

Posted on 29 May 2008 by David Merkel

I’ve used Yahoo Finance since 1997, I think.? What a great resource.? Today, they announced the return of free real-time quotes.? Nice, though I went through three phases in my reaction.? The first was, “Yes, the whole real-time market.” The second was, “What, just an ECN?”? The third was, “Okay, they trade 9% of all shares traded… that’s not ideal, but that’s pretty good.”

Now, how could Yahoo improve this?? At present, the ECN real-time quotes are only available on single stock quotes.? Create a view where they can be applied to portfolios, and things gets a lot better.? Let those quotes stream, and you have an amazing service.

An Annual Warning on Annuity Salesmen

Posted on 29 May 2008 by David Merkel

Beware financial companies that grow rapidly. Beware if you are an investor; beware if you are a consumer; beware if you are a regulator. Fast growth usually means at least one of the following is wrong:

The accounting, whether regulatory or GAAP
Consumer disclosures

I write this evening, because of this long article from Bloomberg on a division of Aegon, namely, World Financial Group. In this case, I don’t know about any accounting difficulties, but the disclosures to consumers are lacking.

The founder of ICH Corp, once said something to the effect of, “Insurance is a great business. You issue promises, and people send you money.” Thankfully, ICH is no longer among us.

Now, I don’t like the annuity business, and I advise my friends only to buy them if they have maxed out all their other ways of saving on a tax deferred basis. Have you maxed out your 401(k)? Your Roth or non-deductible IRA? If you have, and still want tax deferral, a deferred annuity could be useful. Consider getting one from Vanguard, because the fees from everyone else are dreadfully high.

Beyond that, product design is complex for annuities, and people don’t understand their annuities well. In general, I think that small investors are best served through simplicity, and the various variable and equity-indexed annuities don’t pass that test. Aside from that, the insurance industry uses complexity to hide fees.

Now, I have worked for three aggressive life insurers in my time. They wrote annuities like crazy. I know what the sales culture is like from the inside: very focused on getting a product that is easy to sell, and then selling like mad. I’ve also been on the legal committee at one of those insurers, and it is not fun.

My advice remains — buy what you determine to buy, not what someone is trying to sell you. Call for a “time out” at minimum with salesman, and if he will not assent to that, show him the door. Get your network of intelligent friends together, and analyze it if the salesman is willing to wait.

Buyer beware. Unless you have complex tax-avoidance needs, stick to simple insurance products.

Avoid Investment Scams and Bad Advice

Posted on 27 May 200822 June 2017 by David Merkel

There is one fundamental rule on the idea generation process to get across to new retail investors:

Buy what you have researched.? Don’t buy what your friends are buying, or even worse, what someone is trying to sell you.

(For those with access to RealMoney.com, you could review my Using Investment Advice series.)

The point here is to become capable of doing the basic research necessary to make reasonable decisions.? You don’t have to make great decisions in order to succeed.? You do have to avoid making major errors, which requires a degree of skepticism toward the opinions of your non-expert friends, and modest hostility toward those selling investment products.

What led to this article was a eight-page glossy advertisement from a publication that I do not deign to name (I worry about lawsuits), about a company called GTX Corp [GTXO].? Now, maybe I need to refresh my free subscription to the direct mail preference service, which really cuts down on the amount of junk mail that I receive.

GTX Corp is an example of a company with a high valuation, and uncertain prospects.? There is no provision for adverse deviation.? It trades on the Bulletin Board, and here is its business:

GTX Corporation integrates global positioning system (GPS) technology into consumer electronics devices.? The technology allows for real-time oversight of loved ones.

Now, why don’t I like this company, aside from the advertisement that did not mention valuation, balance sheet strength, or any other risk factors?

It trades at a high ratio of book, and trailing earnings don’t exist.
It was created out of a merger with a failed mining company.
Its recent financing this month offered equity interests far cheaper than the current market price.
Their auditor is not a major auditing firm.
Give the auditor credit though, they did not give them a “going concern” opinion, but instead expressed doubts.
The stock is on the Nasdaq’s Threshold Securities list, so finding shares to short is problematic.
Major shareholders are doing a secondary offering.
The advertiser was paid $186,000 to do the ad by a third party.

I have no idea how good their GPS technology might be, but there are too many risk factors here to make me even consider a long position.

I am not here to beat on GTX Corp.? I am using them, and the guy who advertised them as an example.

The advertisement had all manner of positive things to say about the technology and what it could do.? That’s fine, but what has it done?? Why doesn’t this corporation have significant revenues?
Why does the ad use the scam language “as featured on” and “as seen in,” naming prominent publications and channels, when all he likely did was buy some slack advertisements at a late hour, or in regional editions?
The ad compares the company to Garmin and other successful companies.
The ad uses a bunch of emotive problems that the technology could solve.
The ad puts forth a target price of $12 without any justification.

Buyer beware, and don’t listen to strangers giving you advice.? Cultivate networks of knowledgeable friends who are trustworthy, and avoid getting taken for a ride by slick-talking (writing) hucksters who pitch clever ideas to you.? Do your work, and buy cheap, boring ideas like I do.

Facilitating the Dreams of Politicians

Posted on 25 May 2008 by David Merkel

I’m a life actuary, not a pension actuary, so take my musings here as the rant of a relatively well-informed amateur.? I have reviewed the book Pension Dumping, and will review Roger Lowenstein’s book, While America Aged, in the near term.

First, a few personal remembrances.?? I remember taking the old exam 7 for actuaries — yes, I’ve been in the profession that long, studying pension funding and laws to the degree that all actuaries had to at that time.? I marveled at the degree of flexibility that pension actuaries had in setting investment assumptions (and future earnings assumptions), and the degree to which funding was back-end loaded to many plan sponsors.?? I felt that there was far less of a provision for adverse deviation in pensions than in life insurance reserving.

I have also met my share (a few, not many) of pension actuaries who seemed to feel their greatest obligation was to reduce the amount the plan sponsor paid each year.

I also remember being in the terminal funding business at AIG, when Congress made it almost impossible for plan sponsors to terminate a plan and take out the excess assets.? Though laudable for trying to protect overfunding, it told plan sponsors that pension plans are roach motels for corporate cash — money can go in, but it can’t come out, so minimize the amount you put in.

The IRS was no help here either, creating rules against companies that overfunded plans (by more than a low threshold), because too much income was getting sheltered from taxation.

Beyond that, I remember one firm I worked for that had a plan that was very overfunded, but that went away when they merged into another firm which was less well funded.

I also remember talking with actuaries working inside the Social Security system, and boy, were they pessimists — almost as bad as the actuaries from the PBGC.

But enough of my musings.? There was an article in the New York Times on the troubles faced by some pension actuaries who serve municipalities.? For some additional color, review my article on how well funded most state pension and retiree healthcare plans are.

Pretend that you are a financial planner for families.? You can make a certain number of people happy in the short run if you tell them they can earn a lot of money on their assets with safety — say, 10%/year on average.? Now within 5 years or so, promises like that will blow up your practice, unless you are in the midst of a bull market.

Now think about the poor pension actuary for a municipal plan.? Here are the givens:

The municipality does not want to raise taxes.
They do want to minimize current labor costs.
They want happy workers once labor negotiations are complete.? Increasing pension promises little short term cash outflow, and can allow for a lower current wage increase.
A significant number of people on the board overseeing municipal pensions really don’t get what is going on.? It is all a black box to them, and they don’t get what you do.
You don’t get paid unless you deliver an opinion that current assets plus likely future funding is enough to fund future obligations.
The benefit utilization, investment earnings, and liability discount rates can always be tweaked a little more to achieve costs within budget in the short run, at a cost of greater contributions in the long run, particularly if the markets are foul.
There are some players connected to the pension funding process that will pressure you for a certain short-term result.

Even though I think pension plan funding methods for corporate plans are weak, at least they have ERISA for some protection.? With the municipal plans, that’s not there.? As such, more actuaries and firms are getting sued for aggressive assumptions, setting investment rates too high, and benefit utilization rates too low.

The article cites many examples — New Jersey stands out to me because of the pension bonds issued in 1997 to try to erase the deficit they had built up.? They took the money and invested it to try to earn more than the yield on the bonds — the excess earnings would bail out the underfunded plan.? Well, over the last eleven years, returns have been decidedly poor.? The pension bonds were a badly timed strategy at best.

Now, like auditors. who are paid by the companies that they audit, so it is for the pension actuaries — and there lies the conflict of interest.? One of my rules says that the party with the concentrated interest pays for third-party services, so it is no surprise that the plan sponsor pays the actuary.? I’m not sure it can be done any other way, unless the government sets up its own valuation bureau, and tells municipalities what they must pay.? (Now, who will remind them about Medicare? 😉 )

The suits against the pension actuaries and their firms could have the same effect as what happened to Arthur Andersen.? These are not thickly capitalized firms, and many could be put out of business easily.? For others, their liability coverage premiums will rise, perhaps making their services uneconomic.

Finally, the flat markets over the last ten years have exacerbated the problems.? Partially out of a mistaken belief that the equity premium is large (how much do stocks earn on average versus cash), actuaries set earnings rates too high.? The actuarial profession offers some guidance on what rate to set, but the reason they can’t be specific is that there is no good answer.? With all of the talk about the “lost decade,” well, we have had lost decades before, in the 30s and 70s.? Even if the statistics are correct for how big the equity premium is, equity performance comes in lumps, and in the 80s and 90s, when we should have taken the returns of the fat years and squirreled them away for the eventual “lost decade,” instead, politicians increased benefits as if there was no tomorrow.

The states and smaller government entities have dug a hole, and they will have to fill it somehow.? Lacking the ability to print money, they will raise taxes as they can, and borrow where they may.? We are seeing the first pains from this today, but the real crisis is 5-10 years out, as the Baby Boomers start to retire.? You ain’t seen nothin’ yet.

Financial Literacy for Children

Posted on 30 April 2008 by David Merkel

As we were driving down the highway Monday evening, back from our oldest daughter’s symphony concert at U-MD, my wife and I began talking about teaching children about money.? We homeschool, so we have to consider a lot in training our children for the real world.

Some of my children have an interest in the market, some don’t. Personalities differ, but you want to give them some core knowledge that everyone can use. There have been people in our home school get-togethers who when they find out I am an investor, they ask “Do you know of any good books on the stock market for kids?” Lamely, I suggest the out-of-print book by Ken Fisher’s son, Clayton, which is pretty good, but I didn’t think it was definitive.? One has complained to me about the Stock Market Game, which seems to teach speculation, not investment.

That’s true of most stock market contests — the only exception I can think of was the Value Line contest back in 1984 . I managed to place in the top 1%, but not high enough to win. That contest forced you to pick 10 stocks from ten different groups for six months. The stocks were sorted by price volatility deciles, so you had to pick some volatile stocks and tame stocks. The stocks were equal weighted, and there was no trading. Great contest — I would love to run something like that. I have suggested it to The Street.com, but no dice. Hey, maybe Seeking Alpha would like to try it! Nominal prize money, but there would be bragging rights!? (Abnormal Returns, this could work for you as well…)

My wife tells me to think about it. Well, today, as I’m going through my personal e-mail, I run across a note from the Home School Legal Defense Association promoting the National Financial Literacy Challenge. Timely, I think. They are having a competition based off of the national standards published in 2007 by the Jump$tart Coalition for Personal Finance.

So I look at the standards, and I think, “These are pretty detailed… how can you turn this into a usable curriculum?”? I print them out and read a little bit of them to my wife Ruth, who says, “Typical for those that set standards, and aren’t teachers; you can’t work with that stuff.”? My wife was a high school teacher, and despite that hindrance, she still homeschools well.? But she knows the troubles that come to public school teachers as mandates come down from on high.

She asked me, “What would you recommend, then?”? I thought about it and said that the personal finance book that I reviewed recently, Easy Money, would be a good book for high school seniors to read.? It’s not a complex book at all.? Afterward I would discuss it with them.? She asked me why I hadn’t done that for our older two children and I said, “It was published after they went to college.? I’ll ask them to read it this summer.”

For investing, I still think that Buffett’s Annual Reports are understandable to most teens.? Marty Whitman is easy to read as well.? But I always liked Ben Graham, and I think The Intelligent Investor is accessible to the average teenager.? Good investing is not complex… but often we make it so.

Full disclosure: if you enter Amazon from my links and buy anything, I get a small commission.? It is my substitute for the tip jar, and it doesn’t increase your costs at all.

I Don’t Get It

Posted on 23 April 2008 by David Merkel

1) Liberty Mutual buys Safeco?? Pays 1.75x book, and 11x estimated earnings?? Mutual companies have limited access to the credit markets, and have no equity to pay with, so it is mainly a cash deal.? They must have had a lot of cash lying around — might we wonder why they might not have enhanced policyholder dividends instead?? This is not an economic use of capital in my opinion. Kudos to those who owned Safeco — it was cheap, though in the negative part of the underwriting cycle.

I know this diversifies Liberty Mutual geographically and from a line of business standpoint, but I don’t expect there are a lot of costs to take out here. Intellectually, it is harder to grow organically, but at this point in the underwriting cycle, it is definitely preferred to acquisitions.? There are no equity investors in Liberty Mutual, but I would not lend them money on a trust preferred or a surplus note at present.? There are better places to put money at interest — remember, acquirers usually underperform.

But for those with a RM subscription, check out Cramer.? Off of Safeco, he likes Chubb.? Okay, I like Chubb too.? Great company, and cheap.?? I prefer Allstate, HCC, or Safety, and if I wanted to speculate, maybe Affirmative.? Lots of cheap P&C names out there, but it is the wrong side of the underwriting cycle — premiums falling, losses coming in unabated.

2) I don’t get fundamental weighting on bonds.? With bonds, the best one can do is get paid interest and principal, if one is buy-and-hold.? With stocks, a buy-and hold investor can do better in the long run by buying better earnings streams (value), rather than accepting market value weightings.? With bonds, there is no such upside, so I don’t get the fundamental weighting, except perhaps in foreign currency denominated bonds, and using purchasing power parity, which is still a weak tool.? I wouldn’t go there.

3) I don’t get Bill Miller.? I’m a value investor.? I like companies that trade at modest multiples of book and earnings.? I agree in principle with the concept of deferred performance that he mentioned in his quarterly letter:

My friend Jeremy Hosking, who has delivered around 400 basis points per year of excess return over two decades at Marathon (in London), corrected me recently when I spoke about our underperformance. “You mean, your deferred outperformance,” he said. I thought it a clever line, but it contains an important point. For investors who are trend followers, or theme driven, or who primarily build portfolios around forecasts, or who employ momentum strategies, price is dispositive. When they do badly, it is because prices moved in a direction different from what they thought. For value investors, price is one thing, and value is another. When prices move against us, it usually means that the gap between price and value is growing, and our future expected rates of return are higher.

With stable, cheap businesses, this definitely applies, but as you step out onto the growth spectrum, it no longer applies.? Check out the beginning of the letter, he is only 41 basis points ahead of the S&P 500 on a ten-year basis.? At this rate next year, he might be behind the S&P over ten years.? Quite a flameout for one who was so lionized.? Could he be fired?? Yes, but not by Chip Mason.? They are too close.? If one succeeds unconventionally, there is less tolerance for failure, because they weren’t sure why it worked in the first place.

4) I’ll take the opposite side of this trade.? Financial literacy is a good thing, and most people would be better off knowing more about finances, so long as they can mix it with humility.? I’m a professional, and I think humility is a key virtue in handling money.? As I say in my disclaimer:

David Merkel is an investment professional, and like every investment professional, he makes mistakes. David encourages you to do your own independent “due diligence” on any idea that he talks about, because he could be wrong. Nothing written here, or in my writings at RealMoney is an invitation to buy or sell any particular security; at most, David is handing out educated guesses as to what the markets may do. David is fond of saying, “The markets always find a new way to make a fool out of you,” and so he encourages caution in investing. Risk control wins the game in the long run, not bold moves.

People who are educated will still make mistakes with their money, but they will make fewer mistakes on net.? Hey, I’ve paid market tuition, and it is painful.? But boy, I learned a lot, and I don’t repeat mistakes often.? (Repeating mistakes sometimes is bad enough… 😉 )

Full disclosure: long SAFT (not SAF)

Book Review: Pension Dumping

Posted on 23 April 200812 February 2011 by David Merkel

I?m an actuary, but not a Pension Actuary. I don?t understand the minutiae of pension law; I only know the basics. Where I have more punch than most pension actuaries is that I understand the investing side of pensions, whereas for most of them, they depend on others to give them assumptions for investment earnings. I?ve written on pension issues off and on for 15 years or so. I remember my first article in 1992, where I suggested that the graying of the Baby Boomers would lead to the termination of most DB plans.

I am here to recommend to you the book Pension Dumping. It is a very good summary of how we got into the mess we in today with respect to Defined Benefit [DB] pension plans. Now, much of the rest of this review will quibble with some aspects of the book, but that does not change my view that for those interested in the topic, and aren?t experts now, they will learn a lot from the book. The author, Fran Hawthorne, has crammed a lot of useful information into 210 pages.

The Balancing Act

One of the things that the book gets right is the difficulty in setting pension regulations and laws. In hindsight, it might have been a good idea to give pensioners a higher priority claim in the bankruptcy pecking order. But if that had been done, many companies might have terminated their plans then and there, because of the higher yields demanded from lenders who would have been subordinated.

She also covers the debate on the ?equity premium? versus immunization well. Yes, it is less risky to immunize ? i.e., buy bonds to match the payout stream. Trouble is, it costs a lot more in the short run. With equities, you can assume that you will earn a lot more.

She also notes how many companies were deliberately too generous with pension benefits, because they did not have to pay for them all at once. Instead, they could put up a little today, and try to catch up tomorrow.

Things Missed

? Individuals aren?t good at managing their own money. Even if a participant-directed 401(k) plan is cheaper than a DB plan in terms of plan sponsor outlay, the average person tends to panic at market bottoms and get greedy at market tops. DB plans and trustee-directed DC plans are a much better option for most people. That said, most people prize the illusion of control, and will not choose what is best for them.
? Technological progress was probably a bigger factor in doing in the steel industry, and other unionized industries, than foreign competition. Nucor and its imitators did more damage to the traditional steel industry than did foreign competition. With commodity products, low price wins, and Nucor lowered the costs of creating steel significantly.
? In the analysis of what industries could face pension problems next, she did not consider banks and other financial institutions. Most of those DB plans are very well-funded. Why? They understand the compound interest math, and the variability of the markets. But what if the current market stress led to financial firms cutting back on their plan contributions?
? She gets to municipal pensions at the end, and spends a little time there, but those face bigger funding gaps than most private plans. Also, she could have spent more time on Multiple Employer Trusts, where funding issues are also tough, and plan sponsor failures leave the surviving plan sponsors worse off.
? She also thinks that if you stretch out the period of time that companies can contribute in order to fund deficits, it will make things better. In the short run, that might be true, but in the intermediate term, companies that are given more flexibility tend to get further behind in funding DB pensions.
The book could have spent more time on changes in investing within DB pension plans, which are drifting away from equities slowly but surely, in favor of less liquid investments in private equity and hedge funds. How that bet will end is anyone’s guess, but pension investors at least have a long time horizon, and can afford the illiquidity. My question would be whether they can fairly evaluate the skill of the managers.

Summary

This book describes the motives of all of the parties in DB pension issues very well, and why they tend to lead to DB plan terminations. There are possible solutions recommended at the end, but in my judgment they might save some plans that are marginal, but not those that are sick. If you are interested in the topic of pensions, buy the book, and if you buy it through the links above, I get a small commission. (If you buy anything through Amazon after entering from a link on my site, I get a small commission. That?s my tip jar, and it doesn?t raise your costs at all.)