PANEL 4: THE FED?S EXIT STRATEGY VS. FUNDAMENTAL REFORM
Moderator: Craig Torres
Reporter, Bloomberg
Jerry L. Jordan
Former President, Federal Reserve Bank of Cleveland
Lawrence H. White
Professor of Economics, George Mason University
Kevin Dowd
Professor of Finance and Economics, Durham University
Torres introduces White, who talks about the need for a Fed exit from credit policy
QE was not a monetary policy. ?M2 anemic amid a huge rise in the monetary base. ?High powered money ain’t. ?Did not want to see M2 rise, which would lead to inflation.
Fed sterilized through interest on excess reserves [IOER]. ?This favored housing over other uses of credit. ?Fiscal policy masquerading as monetary policy.
Dramatic impact on its portfolio duration and income. ?Record interest income. ?Most gets?gets rebated to the Treasury, rest to the banks. ?Thinks Fed’s average maturity has moved from 4 to 12 years. ?Buiter predicted it. ?Fed is doing it all?for the Treasury.
Fed shouldn’t allocate credit. ?Takes away Congress’s job of wasting money. [DM: he said it, not me] ?Now a demand comes for a Puerto Rico bailout. ?Can’t give away money costlessly, even if you print it.
Lowers penalty for failure. ?At present the Fed has no plans to exit credit allocation; Congress will have to act to end it.
Jerry Jordan: Fed built the financial bubble. ?13th Fed res bank? ?Think he’s talking about Fannie and Freddie…
Monetary authorities as eunuchs. ?Political Viagra needed. ?Has fiat money run its course?
Foreign banks borrowing from the FHLB.
Money multipliers broken, high powered money does not exist. ?Central bank balance sheet is unrelated to money conditions in the economy. ?QE can be contractionary. ?There is no possible exit from QE. ?Stopping QE was good, but ending it will not happen, because IOER and reverse repos are the rule. ?IOER borrows from banks and RR borrows from money market funds and GSEs.
Zero experience on IOER and Rev repos. ?Who knows what would happen if inflation rose?
Conclusion: aggressive Fed policy has had no impact on inflation, and the Fed does not truly affect credit at present. ?Thee are no tools now for dealing with a rise in inflation.
Torres: things are anything but normal now.
Dowd: Extreme Keynesian Policies have not delivered.
Hi recommendation: Recommoditize the dollar, recapitalize the bank, restore strong governance to banking, and roll back government intervention
?? Put Hetty Green on the $10 bill!
Commodity standards with a feedback rule. [DM: quack, quack]
Banks need to run with high levels of capital in order to take more risks. ?Higher standards, and less gameable. ?Riskier positions would be penalized.
Banks would not be able to pay bonuses, dividends, buy back stock until they were compliant. ?SIFI banks only at 7% GAAP capital, 5% under IFRS. ?Social consequences of higher bank capital levels are zero. ?Capital is not a “rainy day fund.” [True]
Bank directors would be limited to unlimited personal liabilities. ?Bring back double liability for shareholders? ?Unlimited liabiity for shareholders. ?Look at the investment banks; when they went public, they threw risk control away.
GSEs and Fed ?would be wound down. ?Oligarchy of bankers block reform. ?Take the crony out of capitalism.
Q&A
1) High capital requirements but deregulating — what are you proposing??Depositors will seek highest return, and create another type of moral hazard.
D: Aims for getting the government out of the economy.
2) Bert Ely: possibility for capital arbitrage? ?Also shadow banking?
D: Capital rules created capital arbitrage.
Another fellow suggested that banks would be entirely equity funded.
3) Question on abolishing cash?
D: Deflationary collapse.
4) What would happen if people were taxed for holding cash?
Much held by foreigners — punish them with negative interest rates. ?But it will never happen.
5) To Larry: what of negative interest rates. ?Wouldn’t assets still stay at the Fed for regulatory reasons?
W:???
6) Transition from monetary to fiscal policy at the Fed?
Bernanke’s theory was that housing had to be preserved above all else. ?Same thing for long term rates. ?Debt service costs to Treasuries reduced.
7) Wouldn’t negative interest rates destroy GDP?
Yes. then asked about whether there were any bond investors. ?Asked what would happen if the Fed tried to sell its mortgages.
Answer from one manager: I wouldn’t want to be the first buyer, and I wouldn’t trust the actions of the Fed… so the market and prices would back up considerably.
The Knowledge Problem — Hayek argued that knowledge is dispersed — impossible to aggregate it without incentives. ?What everyone knows is more than what regulators know. ?There is no way that a central planner (or banker) could know what the right answer is for economics. ?As such, socialism morphed to become social democracy. ?USSR collapsed.
Rules encapsulate important knowledge gained by society over time, which enables actors to have a better idea of what to do. ?Disclosure reduces fraud.
Monetary policy discretion gives too much power to a small group of men.
Pollock says that the Fed does not know what it is doing, and can’t know what it is doing. ?The problem is too complex, and the knowledge to get and interpret to too hard. ?Fed biggest SIFI of all, and creates more systemic risk than anyone. ?The Fed as a result has not done well in the past, and is unlikely to do so in the future.
Financial instability was not destroyed by the Fed; experts are often given to aggressive actions from bad theories. ?Faith in experts is a secular religious problem.
Prices quintupling in a lifetime is considered price stability.
“The Fed must be independent.” But if the Fed is not competent, then should it be independent? ?How and to whom should the Fed be accountable. ?No part of a democratic government should be unaccountable. ?The Fed must be responsible to Congress. ?That said, the Fed has often been a useful lapdog to the Congress… funding deficits, etc. ?Congress in 1963 agreed with this idea at the 50th anniversary of the Fed.
Humphrey Hawkins does not help accountability. ?Financial Accountability Improvement Bill — FOMC would have to make detailed reports to the Congress, including dissenting opinions.
Banking committees in both houses captured by the housing industry.
Calls for a joint committee on the Federal Reserve; should also be able to audit the Fed in any way appropriate.
“The money question” affects so many things that it needs to be broadly discussed.
David Malpass — Post-monetarism: the Fed’s Growth Options
Negative effects of Fed policy on the economy. ?Fed is huge and distortive.
ECB — buy anything at any time.
ZIRP will weigh on growth for decades.
Post-monetarism — direct regulation of the financial system. ?Monetary and credit policies merged. ?Credit growth is slower as a result. ?Required bank reserves have fallen and are rising now. ?No transmission of M0 into other aggregates. ?Fed buys long bonds and advantages them — benefits government and corporations.
Core capex orders are weak. ?Employment to population ratio at a low, forget the unemployment rate. ?Median household income is declining — increased inequality.
Fed has four options to boost growth:
a) move rates above the zero bound. ?Aids savers and would be a loosening of credit. ?Maybe the interbank laon market would increase.
b) taper reinvestment, and free up Treasuries for liquidity and collateral. ?Fed assets at $4.5T. ?Banks assets currently at Fed.
c) Increase repo borrowing. ?Fed Liabs at $4.4T. ?More credit gets pushed out to banks. ?Would be more idle cash to lend.
d) Fed has a severe bunching of maturing assets in the short run. ?Presently would invest maturing assets long. ?Should the Fed own long duration assets?
Q&A — 1) no one has the interests of everyone else at heart. ?Central bankers have poor incentives — they maximize for themselves
O’D: even with good motives, they can’t get it right
M: Quis Custodes Custodiet.
2) Freedom: gold can’t be counterfeited, debased, maximize freedom.
P: American dollar good as gold — Bretton Woods. ?Silver Certificates were repudiated.
Labor gets reallocated to lower productivity areas
Sectoral misallocation of resources — 6% of GDP lost
Allocation, not total amount of credit is key. ?Blancesheet reform and structural reforms. ?Macroeconomic models need to move beyond one simple benchmark.
3) Deflation can be good or bad — deflation is not always bad for output — the link between deflation and growth?is weak, and nonexistent without the Great Depression
No evidence of Fisherian debt deflation, but property prices react to private debt levels. [DM: not sure what he is going for here]
Supply driven deflations are good, demand driven bad.
Thus move away from deflation to avoiding financial crises.
4) Different view of the fall in real rates — Global rise in debt, and rates go lower because it is difficult to incent people to take on more debt.
Low rates in one place can influence behavior elsewhere — thus the recent increase in external dollar liabilities. ?Also, low interest?rates globally.
5) Early warnings of banking distress — if we focus on financial crises, how do you craft policy?
If you use credit measures — can get a better view of GDP
Macroprudential policy operates in a similar way.
Focusing on financial crises would neglect inflation.
His conclusion is that a monetary focus on financial stability will lead to the best growth in GDP.
1990s a disequilibrium situation, with asymmetric monetary policy leading to an explosion in debts.
Quotes Twain on what you know that just ain’t so is that which hurts you.
Q&A 1) Tavlas — low inflation makes it difficult to get out of debt. Eurozone deficit nations can’t regain competitiveness, can’t reduce wages enough.
B: You make good points, but asset prices matter highly — we need to look at those.
2) Selgin — if productivity-driven, it will not be deflationary.
B: repair is slow; monetary policy could not do much to fix?a financial crisis
3) Real time, difficult to tell whether supply or demand-driven.
B: Booms and busts would be reduced if we did this.
Moderator: Jeffrey A. Miron
Senior Lecturer, Harvard University, and Senior Fellow, Cato Institute
Charles I. Plosser
Former President and CEO, Federal Reserve Bank of Philadelphia
John B. Taylor Mary and Robert Raymond Professor of Economics, Stanford University
George A. Selgin
Director, Cato Center for Monetary and Financial Alternatives
Scott B. Sumner
Director, Program on Monetary Policy, Mercatus Center, George Mason University
=–==-=-
Missed Plosser.
Got here in time to hear Taylor. Mentions the effects of non-rule-based monetary policy. ?Notes how capital controls are being tolerated more and more. ?More and more volatility in financial markets.
Mentions how he called the change in 2003-5, and how QE is essentially anti-rule in its application. ?”QE begets QE.”
Central banks follow each other more and more. ?Rules based policy is not impossible per se. ?If more nations were to follow them, you could get a global economy that is rule based.
“Rule-based policy begets rule-based policy.” Would not threaten independence of Central Banks.
Selgin — Real & Pseudo Monetary Rules [playing off Friedman Real and Pseudo Gold Standard]
Should rule out capricious monetary policy a la Venezuela — avoid political influence. ?Could allow for a more timely policy than discretion might achieve. ?Rules aid credibility.
Rules are no good if they aren’t followed and enforced. ?Robust rules would not lead to regret.
Pegged exchanged rate is a pseudo-rule. ?Audit the Fed has weak rules and enforcement/consequences.
A psuedo rule could be worse than discretion. ?When the rule breaks there could be negative results.
Suggests that a contractual rule provides sanctions. ?Nonadherence to a standard leads to losses. ?Monetary policy via government promises versus private contract will fail, promises will be broken.
If monetary instruments are targets, easy to achieve, but may not do good for the economy. ?Feedback rules could be the best. ?Long and variable lags will apply.
Dollarization, Bitcoin, blah, blah, blah… slight diss of Scot Sumner
Scott Sumner: Nudge the Fed to a rules based, nominal GDP based approach. ?Central banks move slow. Three pragmatic reforms:
Define stance of monetary policy — is policy easy or tight?
Make Fed more accountable — revisit past policy ex post
Take small steps toward NGDP targeting.
We don’t clearly know whether policy is truly tight or loose. ?What is the right variable?
Interest rates don’t measure the status of monetary policy. ?Asset prices showed policy was tight as prices fell in 2008. ?Mishkin — NGDP.
NGDP looks at both the supply side and demand side. ?Bernanke admitting mistakes [DM: but does not admit anything on the 2000-2005 overexpansion of liquidity].
Asks that the Fed look back over 1-2 years to analyze how monetary policy really was in terms of tightness. ?Level targeting within bounds would give guidance to decisions.
NGDP futures market proposed. ?[DM: that is a punters market, and won’t work.
Q: to Sumner: NGDP includes govt spending, so it can be gamed.
S: too big too exclude. ?Aggregate nominal labor compensation might be better as a target.
Q: David Malpass: what would work better for tight/loose than interest rates?
Taylor: money growth — rules vs not are a more important thing
Q: Bert Ely: Why not let the market dictate policy?
Selgin: that could be gamed. ?Fiat money is artificially scarce. ?Not sure what you would actually target, feed back, etc.
Q: is the dual mandate a good thing?
Plosser: the dual mandate is important. ?Actual text of the dual mandate is important — and it does have its problems, because it creates discretion.
Press conference w/Bullard: embargoed until end of talk. ?[everything is a paraphrase here, and I can’t get everything down, as with everything at this conference]
Neo-Fisherian ideas are interesting and worthy of further talking about, but don’t take them too seriously.
The longer you are at a zero bound — the neo-Fisherian effects get larger.
Q: new monetary consensus of a?low nominal world. ?Won’t the abnormal become normal?
B: ECB and Japan still doing QE. ?We are now?trying to normalize.
Q: Balance sheet. edging up rates?
B: liftoff, then review the balance sheet. ?Gradualism will be the normal policy, more shallow than 1994 or 2006. ?Won’t have credibility on gradualism until the second move. ?More on gradualism — not a constant slope, but state-dependent.
Q: [Bloomberg] ?Why go gradually?
B: He has higher dots. ?Forecasts lower unemployment. ?Need to see how things evolve.
Q: Wan’t it difficult for the Fed to veer from prior policy moves?
B: You have to retain your options, and move accordingly. ?Labor markets could tighten considerably.
Q: [Dow Jones] Any concern that you will have unanticipated effects on the ECB and World?
B: No. Those are priced in anyway.
Q: keeping the markets calm?
B: we won’t give a total roadmap, we can’t. ?It won’t be like 1994. ?We will communicate more.
Q: Chorus of criticism from the GOP?
B: Fed has been in the middle of the action since the crisis. ?Adds to a healthy debate on priorities for monetary policy. ?What should we have has targets…
Q: Is the FOMC shifting its official inflation measure? ?Dallas Fed Trimmed Mean?
B: Trimmed mean is better statistically. ?Target should be overall inflation.
Now it is time for Lacker
Jury is still out on how we handled on 2008-9. ?Not surprised on the political furor.
Q: What will happen when FOMC raises rates?
L: should be smooth. ?News will be in the announcement. ?Shouldn’t be a surprise.
Q: ??
L: My dots are above median. Should be a flatter cycle.
Q: Regarding his paper, if the price level is all that matters, why not have the 2% more prominent?
L: Can’t reject the possibility that chance is keeping inflation low, and a slow-moving component. ?Communications are pretty clear now.
Q [marketwatch] FOMC behind curve?
L: We might be, we might not.
Q: Possible that Fed won’t be gradual?
L: Possible. ?Consider inflation 2003-2004 to 2007, we got behind on inflation.
Q: any reform ideas you might support?
L: IOER given to Board, should go to the FOMC.
Q: should a Taylor rule be mandated?
L: wouldn’t mandate it, we even consider them, and maybe we should discuss why we differ from them.
Q: your view on the balance sheet?
L wind down quickly, if possible.
Q: my question on whether globalization and technology affecting the ?labor share and thus monetary policy?
L: models could take account of that if they wanted to — depends what you think the goals of policy are. ?If inflation only, a focus on employment might have an effect, or we could end up pursuing pushing for unemployment that we can’t achieve.
Moderator:Jon Hilsenrath
Chief Economics Correspondent, Wall Street Journal
Jeffrey M. Lacker
President and CEO, Federal Reserve Bank of Richmond
George S. Tavlas
Member, Monetary Policy Council, Bank of Greece
Manuel S?nchez
Deputy Governor, Bank of Mexico
Panel starts with Hilsenrath introducing?Manuel S?nchez. ?Argues that monetary policy should have modest objectives. ?Takes a conventional view that some inflation is good, that monetary policy is powerful and can deal with macroeconomic problems. ?Favors the lender of last resort powers of the Central Bank a la Bagehot.
Monetary policy can best serve markets by not being distracted from the main goals — low inflation and macroeconomic stability. ?If monetary policy gets too many goals, it will not achieve its important goals, and may not truly achieve much useful at all. ?After all, look at the loose policy prior to the Great Depression, and possibly loose policy prior to the recent financial crisis.
Current policy may be creating financial imbalances now, and lack of incentive for governments to get their own houses in order.
Emerging economies have their own issues with monetary policy, with many cutting rates (DM: competitive devaluation). ?Now many emerging economy central reverse those moves, amid rising risks.
Now?George S. Tavlas — should monetary policy be based on rules vs discretion? ?Taylor Rule makes monetary policy transparent and predictable. ?Failure to follow the Taylor Rule 2003-6 led to the financial crisis. ?Bernanke argues for freedom.
Asks what would Milton Friedman would do now? ?Depends on which Milton Friedman you talk about, as he was a Keynesian (1946) and became a monetarist. ?W/Schwartz in 1948, started writing their book on monetary policy. ?Their arguments stemmed from the long run effect, versus a short run effect which could be highly variable. ?Argued that the collapse of monetary aggregates in 1929-32 led to the Great Depression, and that a simple rule could prevent stupid policymakers.
Friedman felt that feedback policy rules?injected too much judgment and discretion, and model risk.
Yet they would be better than raw discretion. ?Arthur Burns, teacher of Friedman in the 50s, former Fed Chair, gave into political pressure. ?Tavlas thinks that the performance of monetary policy in 90s would favorably dispose Friedman to a Taylor rule.
Cites what Bernanke said to Friedman at his 90th birthday. ?Odd comment on how a rule at U Chicago led to Friedman’s marriage to Rose.
Now?Jeffrey M. Lacker,?President and CEO, Federal Reserve Bank of Richmond. ?Argues that monetary policy is undiminished in its ability to affect the price level in the long term. ?Ability to affect real variables is limited and transitory.
Argues on a popular view of resource use a la the Phillips curve — that overuse of resources leads to inflation.
Argues that the zero lower bound does not constrain policy now, but that short rates should rise now. ?The existing inflation rates may be overly low for random reasons.
Doesn’t think that the increase in the Fed’s balance sheet has any long-term effect on the economy.
Argues for limited goals for monetary policy.
Q&A 1 — Hilsenrath: talk about monetary policy inflation targets. Gold standard, NGDP, etc., should there be a discussion for a new target on monetary policy?
Lacker — present target works well. ?Absent a rule a la Taylor other rules will not work well. ?Gold standard does not work well, and does not provide price stability.
Hilsenrath — Asset inflation?
Lacker — that should not be a goal for monetary policy.
Tavlas — gold standard had adjustment methods that worked pre-1914. ?Unemployment was not a consideration. Union power in the 20s pushed for employment as a factor in monetary policy, and wages would no longer adjust lower.
Argues that when rates were?raised to deal with an incipient asset bubble — great depression. ?Eventually said that the CPI was a fine goal.
Sanchez also agrees with a CPI goal. ?Says it is difficult to spot bubbles, and they may be due to fiscal policies.
Q2 — Mike Mork, ?asks?about the drop in velocity of M2. ?Why?
Lacker doesn’t know. ?(Nice honest answer.) ?Increase in currency abroad?
Q3 — Lacker says that non-economists are a good influence on the FOMC and a diversity of views.
Q4 — Hilsenrath — Is there a monoculture of views among Ph.D. economists at the Fed.
Lacker — Economists disagree with each other.
Q5 — Josh Crum — what do you do with people bypassing banks in the future?
Lacker — not sure how what the Fed can or should do on that issue. ?Has a lot of thoughts, but not so many conclusions. ?Mentions repos and money market funds, and the need for maturity transformation.
Q6 — Hilsenrath — should the ECB do more QE?
Tavlas — ECB thinks they can’t affect real variables, but can affect price inflation.
Hilsenrath — but is it working?
Tavlas — takes time for monetary policy to work. ?Should eventually work.
Q7 — David Malpass — will the Fed raising rates be stimulative?
Lacker can’t see stimulus. ?Can’t see how credit demand would increase even if supply does.
Q8 — Hilsenrath asks how Fed’s moves may affect Mexican monetary policy
Sanchez — Fed creates volatility,?with rising rates peso may devalue, and inflation may rise in Mexico, but we will adjust to conditions as the Mexican economy changes. ?They will takes foreign monetary policy into account as it affects inflation.
He thinks they have been lucky so far.
Hilsenrath — how does the global slowdown affect your policy?
Sanchez — can’t avoid taking the Fed into account, they are just too big.
He’s arguing that monetary policy has been too loose for too long, though a zero percent policy was needed for a time. ?Cites this paper here. ?Gives a confusing neo-Fisherian model — simple models don’t do justice to a complex economy. ?Argues that low rates lead to low price inflation. ?(Personally, all of this neglects demographics, and the relative propensity of monetary policy to funnel marginal money into asset or goods markets.)
Monetary policy near the zero bound creates its own demand for abnormal policy tools. ?Thinks that economy is pretty normal now, and there is no need for excess stimulus now. ?Thinks that current policy will lead to bad results if maintained.
Q&A — Selgin of Cato — Says Fisher would spin in his grave, that public natively facilitates Fed policy, which is not natural.
Fisher argues that you have to have an equilibrium concept in economics. ?How than to explain low rates and low inflation.
Q2 — Politics and the Fed — what does he think of GOP candidate comments?
In general, people don’t do well with amounts of money significantly larger than they are used to handling. ?The most obvious example of that is people who win lotteries. ?The money typically gets wasted — bad purchases, bad investments.
Thus I would encourage you to be very careful with any large distributions of money that you might receive. ?Examples include:
Life insurance settlements
Disability insurance settlements
Structured settlements arising from winning a court case over a tort against you.
Lotteries
Pension lump sums
Inheritances
Big paydays, if you are one of the rare ones in a high-paying short career like entertainment or sports
There are three problems with lump sums — receiving them, investing them, and rate of their use for consumption. ?Let me take these topics in the order that they should occur.
Receiving a Lump Sum
Let’s start with the cases where you have?a stream of payments coming where a third party comes to you and says that you can get all of the money now. ?I am speaking of structured settlements and inheritances where trusts have been structured to dole out the money slowly. ?There is one simple bit of advice here: don’t do it. ?Take the payments over time. ?None of the third parties offering to give you cash now are giving you a good deal, so avoid them.
Then there are the cases where an insurance company is making the payments from a disability claim, a structured settlement, a lottery, a pension buyout, or an annuity that someone bought for you on your life. ?The insurance company will be more fair than any third party, because they aren’t usually looking to make an obscene gain, just a big one, because it reduces their risk, and cleans up their balance sheet, so they can do more business. ?One simple bit of advice here: still don’t do it. ?You can do better by taking payments, and building up money for larger purchases. ?Be patient.
People do best when they receive money little by little. ?When they get money materially faster than the speed at which they have previously earned money, they tend to waste it. ?It is almost always better not to take a lump sum if you have the option to do otherwise.
The last set of situations is when the party that owes the set of payments?offers you a lump sum. ?It could be a life insurance company, a defined-benefit pension plan, a lottery, or some option uncommonly granted by another payor. ?I would still tell you not to do it, but the issue of getting cheated is reduced here for a variety of reasons.
The defined benefit plan has rates set by law at which it can cash you out, so they can’t hurt you badly. ?That said, you will likely not earn enough off of your investments with safety to equal the stream you are giving up. ?The lottery is often similarly constrained, but do your homework, and see what you are giving up.
One place to take the lump sum is with life insurance companies off of a death benefit. ?The rates at which they offer to pay an annuity to you are frequently not competitive, so take the lump sum and invest it wisely.
Economically, the key question to ask on a lump sum versus a stream of payments is what you would have to earn to replicate the stream of payments. ?Most of the time, the stream is worth more than the lump sum, so don’t take the lump sum.
The second question is more important. ?Can you be disciplined and not waste the lump sum? ?Ask those close to you what your money habits are like, if you don’t know for sure. ?Ask them to be brutally honest.
Investing the Lump Sum
Again, one nice thing about taking payments, is that you don’t have to invest the lump sum. ?If you do take the lump sum:
First, pay off high interest rate debts.
Second, avoid buying big things and calling them investments. ?Don’t buy a big house when you don’t need a big one.
Third, don’t invest in any of your relatives’ or friends’ business ventures. ?Tell them you try to keep personal affection and money separate. ?It avoids hurt feelings.
Fourth, look at the time horizon of your real needs. ?Plan for retirement, college, etc. ?Invest accordingly — get a trustworthy adviser who will help you. ?Trustworthiness is the most important factor here, with competence a close second.
Fifth, don’t so it yourself, unless you have developed the skill to do it previously. ?If you want to do it yourself, you will have to gauge whether the various markets are rich or cheap in order to decide where to invest. ?For some general, non-tailored advice, you can look at articles in my asset allocation category. ?As an aside, don’t invest in anything unusual unless you are an expert.
Receiving Spending?Money from Your Investment Fund
The first thing is to decide on a spending rule: many use a rule that says you can take 4% of the assets from the fund. ?My rule is a little more complex, but will keep you safer, and adapt to changing conditions: as a percentage of assets, take 1% more than the yield on the 10-year Treasury Note, or 7% if less. ?At present, that percentage would be 2.21% + 1% = 3.21%.
Whatever rule you use, be disciplined about your spending. ?Don’t bend your spending rule for any trivial reasons. ?Size your budget to reflect your income from your investment fund and all of your other income sources.
Conclusion
Remember that most people who get a lump sum end up wasting a lot of it. ?The only thing that can keep you from a similar fate would be discipline. ?If you don’t have discipline, don’t take a lump sum. ?Take the payments over time. ?That will give you the maximum benefit from what is a very valuable asset.
There was one comment on the article that I would like to highlight. ?Here it is:
The other thing to watch for with retirement spending is not spending enough of your investments, especially in early retirement. Many studies have shown that actual spending in retirement decreases by around 50% from age 55 to age 80. One study in Germany showed that people?s wealth actually started increasing again in their 70?s as their pension incomes exceeded their lifestyle costs, with the resultant increase in savings.
People need to think about this in how they structure their retirement spending. It may make complete sense for someone with a $1 million portfolio and a standard government pension to spend $800,000 of that $1 million by age 80, leaving a $200,000 cushion for the lower cost part of their lives as most of their day-to-day living expenses will be covered by their pension.
People need to spend their money when they are active and mobile and able to enjoy it. I think the financial press needs to talk about this more, so people are not scared into not spending their money until it is too late.
“There is a fine line between over-saving and under-living.”
That particular story dealt with a couple that had been especially frugal, and after not earning all that much, at retirement had $6 million. ?They had a traditional marriage, and the husband handled the money entirely. ?He worked until 72, retired due to incapacity, and on the day of his retirement, he handed his wife a check for $3 million.
She thought it was a joke, so for fun she tried to cash the check. ?To her surprise, the check cleared. ?Then came the bigger surprise — her amazement gave way to anger! ?All the years of self-denial, and they were this well-off! ?There were so many things she denied herself along the way, and now both of them were too old to truly enjoy their riches.
There’s more to the story… the point the author goes for is mostly abut how husbands and wives should learn to cooperate on the shared tasks of household economic management, so that both are on the same page, and they can be agreed on goals and methods.
I agree with that, and would add that the best approach on spending versus saving is what I would call a conservative version of the “middle way.” ?Make sure that you are provident, but balance that with contentment and a happy enjoyment of what you have. ?Life is meant to be lived.
Yes, it is good to be prudent and frugal, but not to the point where you amass a lot of assets and never enjoy them.
[Now for those not crazy about Christianity, you can skip to the end.]
In Ecclesiastes 5:13-20, Solomon says [NKJV]:
There is a severe evil which I have seen under the sun: riches kept for their owner to his hurt. ?But those riches perish through misfortune; when he begets a son, there is nothing in his hand. ?As he came from his mother’s womb, naked shall he return, to go as he came; And he shall take nothing from his labor which he may carry away in his hand. ?And this also is a severe evil? just exactly as he came, so shall he go. And what profit has he who has labored for the wind? ?All his days he also eats in darkness, And he has much sorrow and sickness and anger.
Here is what I have seen: It is good and fitting for one to eat and drink, and to enjoy the good of all his labor in which he toils under the sun all the days of his life which God gives him; for it is his heritage. ?As for every man to whom God has given riches and wealth, and given him power to eat of it, to receive his heritage and rejoice in his labor?this is the gift of God. ??For he will not dwell unduly on the days of his life, because God keeps him busy with the joy of his heart.
Ecclesiastes 4:8 and 6:1-3 say similar things, and are cited by the Larger Catechism in question 142, where it says:
What are the sins forbidden in the eighth commandment?
The sins forbidden in the eighth commandment, besides the neglect of the duties required, are, theft, robbery, man-stealing, and receiving any thing that is stolen; fraudulent dealing; false weights and measures; removing landmarks; injustice and unfaithfulness in contracts between man and man, or in matters of trust; oppression; extortion; usury; bribery; vexatious lawsuits; unjust inclosures and depopulations; engrossing commodities to enhance the price, unlawful callings, and all other unjust or sinful ways of taking or withholding from our neighbor what belongs to him, or of enriching ourselves; covetousness; inordinate prizing and affecting worldly goods; distrustful and distracting cares and studies in getting, keeping, and using them; envying at the prosperity of others; as likewise idleness, prodigality, wasteful gaming; and all others ways whereby we do unduly prejudice our own outward estate, and defrauding ourselves of the due use and comfort of that estate which God hath given us. [Emphasis mine]
Along with questions 140 and 141, they summarize most of what the Bible teaches on ethics in economics. ?My emphasis is the last phrase “defrauding ourselves of the due use and comfort of that estate which God hath given us.”
This may be a surprise to some, but (among other things) God wants us to enjoy life. ?That is not the highest goal, but God commends it through the voice of Solomon in Ecclesiastes multiple times.
Now, not everyone in Christianity thinks this way. ?John Wesley famously said, “Earn all you can. ?Save all you can. ?Give all you can.” ?This is admirable as far as it goes, and Wesley’s life reflected it. ?He was very industrious, frugal, provident and generous. ?But in the middle of his life, he did not purchase?and enjoy some blessings, in an effort to give more to the poor.
Why? ?Black tea was relatively expensive back then, and the lower classes were spending too much of their money on the relative luxury of tea. ?Wesley liked tea a lot, but gave it up for two reasons: to set a good example to the poor, and have more money to give to aid the poor. ?(He also abstained from alcohol, fasted several days a week, and ate cheaply when he did eat.) ?That said, occasionally bothered him that some of the money he gave to the poor got spent by them on tea. ?Oh well. ?With something that is not in itself a sin, it was probably better to let people spend their money as they saw fir, and not discourage them by arguing that tea was a wasteful luxury.
I would amend Wesley and?say it this way, “Earn a?competent amount. ?Save a good portion of it. ?Give to poorer brothers who are ailing, despite doing their best. ?After that, enjoy the blessings God has given you.”
There is a reason why God is portrayed in the Parable of the Lost Son as a generous man who throws a party when his younger son repents of riotous living, while the older son (representing the Pharisees) is portrayed as a miser. ?God is generous, while many religious people get proud of what they have achieved, seemingly apart from God, and resent those who get gifts, while they themselves work. ?This is parallel to salvation, which cannot be purchased no matter how hard we work, but must be received as a gift from Jesus, who did all the work for those who would receive the gift of salvation. ?Echoing that, C. S. Lewis in The Screwtape Letters portrays God as jolly when “the patient” gets a girlfriend, while the demon Screwtape boasts of the grand austerity of Hell.
Closing this section, I would simply say take care of all your other obligations to God, but if God has given you something legitimate to enjoy, then enjoy it, and don’t feel guilty. ?Rather, take the opportunity to thank and praise God for the blessings he brings.
Conclusion
Assets and money are tools. ?They are valuable, but they are a means to an end. ?Use them to enjoy life, while being prudent as you do so.
Investing is difficult. That said, it can be harder still. Let people with little to no training to try to do it for themselves. Sadly, many people get caught in the fear/greed cycle, and show up at the wrong time to buy and/or sell. They get there late, and then their emotions trick them into action. A rational investor would say, ?Okay, I missed that move. Where are opportunities now, if there are any at all??
Investing can be made even more difficult. ?Investing reaches its most challenging level when one relies on his investing to meet an anticipated and repeated need for cash outflows.
Institutional investors will say that portfolio decisions are almost always easier when there is more cash flowing in than flowing out. ?It means that there is one dominant mode of thought: where to invest?new money? ?Some attention will be given to managing existing assets ? pruning away assets with less potential, but the need won?t be as pressing.
1) The retiree doesn?t know how long he, his spouse, and anyone else relying on him will live. ?Averages can be calculated, but particularly with two people, the odds are that at least one will outlive an average life expectancy. ?Can they be conservative enough in their withdrawals that they won?t outlive their assets?
It?s tempting to overspend, and the temptation will get greater when bad events happen that break the budget, whether those are healthcare or other needs. ?It is incredibly difficult to?avoid paying for an immediate pressing need, when the soft cost?is harming your future. ?There is every incentive to say, ?We?ll figure it out later.? ?The odds on that being true will be low.
2) One conservative estimate of what the safe withdrawal rate is on a perpetuity is the yield on the 10-year Treasury Note plus around 1%. ?That additional 1% can be higher after the market has gone through a bear market, and valuations are cheap, and as low as zero near the end of a bull market.
That said, most?people people with discipline want a simple spending rule, and so those that are moderately conservative choose that they can spend 4%/year of their assets. ?At present, if interest rates don?t go lower still, that will likely (60-80% likelihood) work. ?But if income needs are greater than that, the odds of obtaining those yields over the long haul go down dramatically.
3) How does a retiree deal with bear markets, particularly ones that occur early in retirement? ?Can?he and?will he reduce his expenses to reflect the losses? ?On the other side, during bull markets, will he build up a buffer, and not get incautious during seemingly good times?
This is an easy prediction to make, but after the next bear market, look for a scad of ?Our retirement is ruined articles.? ?Look for there to be hearings in Congress that don?t amount to much ? and if they?do amount to much, watch them make things worse by?creating R Bonds, or some similarly bad idea.
Academic risk models typically used by financial planners typically don?t do path-dependent analyses.? The odds of a ruinous situation is far higher than most models estimate because of the need for withdrawals and the autocorrelated nature of returns ? good returns begets good, and bad returns beget bad in the intermediate term.? The odds of at least one large bad streak of returns on risky assets during retirement is high, and few retirees will build up a buffer of slack assets to prepare for that.
4)?Retirees should avoid investing in too many income vehicles; the easiest temptation to give into is to stretch for yield ? it?is the oldest scam in the books. ?This applies to dividend paying common stocks, and stock-like investments like REITs, MLPs, BDCs, etc. ?They have no guaranteed return of principal. ?On the plus side, they may give capital gains if bought at the right time, when they are out of favor, and reducing exposure when everyone is buying them.? Negatively, all junior debt tends to return worse on average than senior debts.? It is the same for equity-like investments used for income investing.
Another easy prediction to make is that junk bonds and non-bond income vehicles will be a large contributor to the shortfall in asset return in the next bear market, because many people are buying them as if they are magic. ?The naive buyers think: all they do is provide a higher income, and there is no increased risk of capital loss.
5) Leaving retirement behind for a moment, consider the asset accumulation process.? Compounding is trickier than it may seem. ?Assets must be selected that will grow their value including dividend payments over a reasonable time horizon, corresponding to a market cycle or so (4-8 years). ?Growth in value should be in excess of that from expanding stock market multiples or falling interest rates, because you want to compound in the future, and low interest rates and high stock market multiples imply that future compounding opportunities are lower.
Thus, in one sense, there is no benefit much from a general rise in values from the stock or bond markets. ?The value of a portfolio may have risen, but at the cost of lower future opportunities. ?This is more ironclad in the bond market, where the cash flow streams are fixed. ?With stocks and other risky investments, there may be some ways to do better.
Retirees should be aware that the actions taken by one member of a large cohort of retirees will be taken by many of them.? This makes risk control more difficult, because many of the assets and services that one would like to buy get bid up because they are scarce.? Often it may be that those that act earliest will do best, and those arriving last will do worst, but that is common to investing in many circumstances.? As Buffett has said, ?What a?wise man?does in the beginning a?fool?does in the?end.?
6) Retirement investors should avoid taking too much?or too little risk. It?s psychologically difficult to buy risk assets when things seem horrible, or sell when everyone else is carefree. ?If a person can do that successfully, he is rare.
What is achievable by many is to maintain a constant risk posture. ?Don?t panic; don?t get greedy ? stick to a moderate asset allocation through the cycles of the markets.
7) With asset allocation, retirees should overweight out-of-favor asset classes that offer above average cashflow yields. ?Estimates on these can be found at GMO or?Research Affiliates. ?They should rebalance into new asset classes when they become cheap.
Another way retirees can succeed would be investing in growth at a reasonable price ? stocks that offer capital growth opportunities at an inexpensive price and a margin of safety. ?These companies or assets need to have large opportunities in front of them that they can reinvest their free cash flow into. ?This is harder to do than it looks. ?More companies look promising and do not perform well than those that do perform well.
Yet another way to enhance returns is value investing: find undervalued companies with a margin of safety that have potential to recover when conditions normalize, or find companies that can convert their resources to a better use that have the willingness to do that. ?After the companies do well, reinvest in new possibilities that have better appreciation potential.
8 ) Many say that the first rule of markets is to avoid losses. ?Here are some methods to remember:
Always seek a margin of safety. ?Look for valuable assets well in excess of debts, governed by the rule of law, and purchased at a bargain price.
For assets that have fallen in price, don?t try to time the bottom ? buy the asset when it rises above its 200-day moving average. This can limit risk, potentially buying when the worst is truly past.
Conservative investors avoid the areas where the hot money is buying and own assets being acquired by patient investors.
9) As assets shrink, what should be liquidated? ?Asset allocation is more difficult than it is described in the textbooks, or in the syllabuses for the CFA Institute or for CFPs.? It is a blend of two things ? when does the investor need the money, and what asset classes offer decent risk adjusted returns looking forward?? The best strategy is forward-looking, and liquidates what has the lowest risk-adjusted future return. ?What is easy is selling assets off from everything proportionally, taking account of tax issues where needed.
Here?s another strategy that?s gotten a little attention lately: stocks are longer assets than bonds, so use bonds to pay for your spending in the early years of your retirement, and initially don?t sell the stocks.? Once the bonds run out, then start selling stocks if the dividend income isn?t enough to live on.
This idea is weak.? If a person followed this in 1997 with a 10-year horizon, their stocks would be worth less in 2008-9, even if they rocket back out to 2014.
Remember again:
You don?t benefit much from a general rise in values from the stock or bond markets. ?The value of your portfolio may have risen, but at the cost of lower future opportunities.
That goes double in the distribution phase. The objective is to convert assets into a stream of income. ?If interest rates are low, as they are now, safe income will be low. ?The same applies to stocks (and things like them) trading at high multiples regardless of what dividends they pay.
Don?t look at current income. ?Look instead at the underlying economics of the business, and how it grows value. ?It is far better to have a growing income stream than a high income stream with low growth potential.
Deciding what to sell is an exercise in asset-liability management.? Keep the assets that offer the best return over the period that they are there to fund future expenses.
10) Will Social Security take a hit out around 2026? ?One interpretation of the law says that once the trust fund gets down to one year?s worth of?payments, future payments may get reduced to the level?sustainable by expected future contributions, which is 73% of expected levels. ?Expect a political firestorm if this becomes a live issue, say for the 2024 Presidential election. ?There will be a bloc of voters to oppose leaving benefits unchanged by increasing Social Security taxes.
Even if benefits last at projected levels longer than 2026, the risk remains that there will be some compromise in the future that might reduce benefits because taxes will not be raised.? This is not as secure as a government bond.
11) Be wary of inflation, but don?t overdo it. ?The retirement of so many people may be deflationary ? after all, look at Japan and Europe so far. ?Economies also work better when there is net growth in the number of workers. ?It will be tempting for policymakers to shrink what liabilities they can shrink through inflation, but there will also be a bloc of voters to oppose that.
Also consider other risks, and how assets may fare. ?Retirees should analyze what exposure they have to:
Deflation and a credit crisis
Expropriation
Regulatory change
Trade wars
Changes in taxes
Asset illiquidity
Reductions in reimbursement from government programs like Medicare, Medicaid, etc.
And more?
12) Retirees need a defender of two against slick guys who will try to cheat them when they are older. ?Those who have assets are a prime target for scams. ?Most of these come dressed in suits: brokers and other investment salesmen with plausible ways to make assets stretch further. ?But there are other scams as well ? retirees should run everything significant past a smart younger person who is skeptical, and knows how to say no when it is necessary.
Conclusion
Some will think this is unduly dour, but this?is realistic. ?There are not enough resources to give all of the Baby Boomers a lush retirement, without unduly harming younger age cohorts, and this is true over most of the developed world, not just the US.
Even with skilled advisers helping, retirees need to be ready for the hard choices that will come up. They should think through them earlier rather than later, and take some actions that will lower future risks.
The basic idea of retirement investing is how to convert present excess income into a robust income stream in retirement. ?Managing a pile of assets for income to live off of is a challenge, and one that most people?are not geared up for, because poor planning and emotional decisions lead to subpar results.
Retirees should?aim for the best future investment opportunities with a margin of safety, and let the retirement income take care of itself. ?After all, they can?t rely on the markets or the policymakers to make income opportunities easy.
