Last month, I presented to the National Association of State Treasurers. The room had all 50 State Treasurers, lots of Deputy and Asst Treasurers, and staff. I was realistic about how credit crises unwind over long periods of time.
The prior panel had the major ratings agency reps, and they had discussed Pension Return Assumptions. Given their utter incompetency, it was no surprise the Ratings firms were okay with expected blended returns of 8%.
An audience member asked a question to me about this, and I laughed. I told the Treasurers that the consultants who tell them they should have expected 8% blended returns for the past 5-10 years were dead wrong, and the ones who told them they could expect 8% blended returns for the next 5-10 years were probably high. My joke was to get to 8% required bad math — blended expected returns of 8% requires taking 5% gains in equities and adding 3% gains in bonds (5+3=8). How often do you get to make a wonky accounting joke to a room full of treasurers?
They’re high all right — that is, high on drugs.
This is their set of assumption:
What Barry is missing in his missive, however, is why this appears to have worked up until the last ten years. The answer is found in my favorite chart, once again:
Let’s look at what the market did as a consequence:
Look closely at those two charts. What I want you to pay attention to is the overlay. Here:
What coincided with the ramp from 1980 forward? Let’s go back ten more years, because it makes the point much clearer. We’ll do it with a nice overlay.
So we had a nice stable stock market, with reasonably-stable leverage (growth in debt .vs. growth in GDP.) Then we started emitting unbacked credit, and lots of it. The market responded. We emitted more. The market responded more.
But then, in 2000, we hit the wall. The emission of new credit over output no longer worked because it was impossible to service the debt with available economic surplus, and the market collapsed.
The response? Even easier credit. Liars loans. Zero-down mortgages. Goading people into speculating on property, taking out HELOCs to buy Suburbans and similar. Frauds were run throughout the financial system in order to prop this up, including issuing CDS and various securities based on claimed credit quality that the writers knew damn well was impossible, as there was at the time a 20 year history that showed credit expansion and thus asset price inflation was the only way it could possibly “work.”
Nobody knew, of course, exactly when the wall would be hit, but that it would happen was inevitable and mathematically certain.
Well now “when” has happened. Yet the same projections on a forward basis are still being run, despite the fact that further credit creation to maintain this bubble in asset prices is not possible, as there’s no ability to pay higher and higher percentages of income in debt service!
This — basic mathematics — is at the root of the problem with these “forecasts.” The people who have made them might have been excused if they made them in 1970 if the goal is to get to 2000, since there’s a “time certain” on the end game. That might have been defensible.
But it’s not defensible on an infinite-forward-horizon basis, which retirement systems always are, since there will always be someone new coming in behind the guy who retires — unless you’re forecasting (and so stating!) the end of the government and/or the company involved on that future “date certain.”
The dynamic that drove this insanity from the mid to late 1970s up until the collapse in 2000 is over. The “last gasp” of fraud attempted in the 2000s to keep the consequences from coming home to roost not only failed it also doubled the damage we must accept in our economy now from what it was in 2000.
This was not an accident and it was not simple “greed.” It was an intentional series of actions and inactions. It was willful in both activity (deficit spending) and blindness (to indefensible acts by financial institutions) by our government acting in concert with The Fed, including the current Chair Ben Bernanke. May I remind everyone that Ben was with The Fed at the time of Greenspan’s actions in the early part of the 2000 decade prior to assuming the Chair?
Do not kid yourselves folks. This is literally 5th grade mathematics — the simple story of exponential growth gone mad, and the inevitable mathematical consequence of two compound functions where one has a higher rate of growth (debt, in this case) than the other (economic output.)
Today, as I write this, we have still not recognized and accepted that this path cannot continue as it is mathematically impossible for it to “work” as we are being told and sold.
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