TO AGE NINETY
Why the collapse of Lehman affects your pension
According to the Social Security Administration, 25% of Americans who reach age 65 will live at least another 25 years to age 90. Considering similar standards of living in other developed countries, it is safe to assume that this statistic applies to a great number of us in the West. This raises the question of whether each one of us has saved enough to support us when we retire.
Excessive leverage in the banking systems of the US and the eurozone led to the last crisis and the collapse of Lehman brothers. Those risks have reduced but did not go away. The risk moved to the Far East and into your pension fund. How can this be?
Entering the crisis, leverage came primarily from the developed world. The years since have seen a brief dose of global deleveraging followed by a huge expansion of Chinese credit. For the past few years, China has functioned as the world’s “borrower of last resort” accounting for 70% or more of new credit from the private sector. Credit is being expanded globally as fast as it was at the peak before the crisis. This has led to deep worries in China that it needs to rein in its debt— a priority for the current regime — and worries elsewhere over whether global economic growth can be sustained while China retrenches. Leverage – excessive or not – did not go away.
Because of the crisis, central banks embarked on quantitative easing which is the policy of buying government and mortgage-backed bonds. This was done to drive down their yields, stave off deflation and encourage investors to take risks. US stock markets enjoyed their longest bull market on record. Real assets, such as real estate which benefits from low interest rates, have also fared well. But markets outside the US fared far worse. While the S&P 500 gained 175% after Lehman fell, stocks in the rest of the world gained only 55 per cent, equivalent to a nominal annual return of barely 4 per cent.
Pension funds, especially in the US but also in Europe, have taken on many of the risks that were once held by banks. Low bond yields, which make it more expensive to guarantee an income, have forced them to take extra risks. They now hold assets, such as hedge fund and private equity investments, with much concealed leverage. Also, many companies have transferred the risk of bad investment performance from their shareholders to savers. Many have switched from defined benefit to defined contribution plans, which means there is no guarantee of a fixed monthly pension but the amount you get depends on the pension fund’s ability – or yours if you take matters into your own hands - to generate good returns.
The US has a much less generous social safety net than western Europe or Japan, and a much stronger tradition of private investment. Surprisingly, most Americans with defined contribution plans do not have anything like enough money saved to support them in retirement. A third of Americans have no money put aside at all. But even among those who are saving, the amounts they have tend to be far short of what they will need. If you want a decent chance of an income of two-thirds of your final salary for the rest of your life, you will need a retirement fund worth more than 10 times that final salary. Only a tiny proportion of Americans is on course for achieving this. If the private pension funds cannot sustain retirees in the future, hugely indebted governments will have to pick up the tab. Germany already sees more application for welfare from retirees who can no longer make ends meet. Many working Germans are awakening to the fact that their future monthly pension will hardly be enough to pay for rent in urban areas let alone food and other expenses.
In Europe, we have long put our trust into governments who would pay pensioners out tax coffers. This is leading to the young generation questioning the sustainability of the generations-contract in light of stretched public finances. In countries with private pension funds and DC schemes, it pays to watch the selection and performance of each fund. No matter your situation, if you want to maintain some of your lifestyle – granted your requirements will likely be inferior – there is no other solution than building up your nest egg
If you would like us to review your pension arrangements and identify risks and undue leverage, please send us an email.
Source: Vladislav Reshetnyak(@vladislav-reshetnyak-66283)
Switzerland, October 2nd, 2018