If economic researchers at the Federal Reserve Bank of San Francisco are correct, America's public pension funds are in even bigger trouble than we thought.
In a recent paper,
Zheng Liu and Mark M. Spiegel suggest a massive stock sell-off by aging baby boomers, who will need to liquidate assets to finance their retirements, will depress equity values in coming decades. Liu and Spiegel aren't the first to embrace this theory, but they have buttressed
it with a statistical model suggesting a strong correlation between
the price-earnings ratio of stocks and the age distribution of the population.
Their money graf:
Of course, such a prediction comes loaded with caveats, and the baby-boom selloff theory has its detractors. As this article notes, the Government Accounting Office came to the opposite conclusion in a 2006 report, concluding that the boomer retirement bulge was "unlikely to precipitate dramatic decline in market returns."
In forecasting asset returns, the one certainty is uncertainty. The pension funds' practice of chasing higher returns through investments in riskier assets inevitably exposes taxpayers to more risk, especially in states that have constitutionally or contractually guaranteed their pension benefits.
While the forecast by the San Francisco Fed paper may, indeed, be too bearish, virtually no one not employed by a public pension fund supports the common government practice of of discounting risk-free pension liabilities at a rate of 7 to 8 percent.
The model-generated path for real stock prices implied by demographic trends is quite bearish. Real stock prices follow a downward trend until 2021, cumulatively declining about 13% relative to 2010. The subsequent recovery is quite slow. Indeed, real stock prices are not expected to return to their 2010 level until 2027. On the brighter side, as the M/O ratio rebounds in 2025, we should expect a strong stock price recovery. By 2030, our calculations suggest that the real value of equities will be about 20% higher than in 2010. [emphasis added]Assuming their model incorporates a 3 percent inflation rate going forward, this would translate into a nominal gain of 25 percent between now and 2021 -- less than one-quarter the assumed rate of return for most pension funds, which are heavily weighted in equities. The Liu-Spiegel "brighter side" scenario doesn't keep pace with pension fund expectations, either.
Of course, such a prediction comes loaded with caveats, and the baby-boom selloff theory has its detractors. As this article notes, the Government Accounting Office came to the opposite conclusion in a 2006 report, concluding that the boomer retirement bulge was "unlikely to precipitate dramatic decline in market returns."
In forecasting asset returns, the one certainty is uncertainty. The pension funds' practice of chasing higher returns through investments in riskier assets inevitably exposes taxpayers to more risk, especially in states that have constitutionally or contractually guaranteed their pension benefits.
While the forecast by the San Francisco Fed paper may, indeed, be too bearish, virtually no one not employed by a public pension fund supports the common government practice of of discounting risk-free pension liabilities at a rate of 7 to 8 percent.
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