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Posted 11/22/2004
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Heads up for pension heartache
If you expect a nice, secure retirement thanks to the pension plan offered by your company, watch out. If stocks fall, youll discover how much these plans are underfunded.
By Bill Fleckenstein
Broken promises come in many shapes and sizes, but they have one thing in common: disappointment. I believe many of the nation's pensions will be a source of that, rather than security, in the future.
Beneath the surface of todays financial environment, there is a huge, smoldering retirement problem, in addition to the fact that Social Security will in essence be unable to satisfy its promises.
I hope I'm wrong, because I think it would be morally reprehensible if a lot of these promises are broken. But as part of the corporate abdication of responsibility that's gone hand-in-hand with the mania (and a similar abdication of responsibility on the part of the Fed), I think many of these pension plans will not be able to withstand a 30%-to-40% drop in the stock market, which I still expect to see at some point.
Fatuous assumptions fatten earnings
Of course, most chieftains in corporate America don't want to employ a safer, sounder asset mix that would be less vulnerable to stock-market problems because it would be more expensive. With the present low level of interest rates, the actuarial assumptions they'd likely have to use would require them to make higher contributions. What the heck do they care about whether the pension plan will be solvent down the road? They just want to contribute the least amount of money to their plans so that their earnings look as good as possible.
Retirement won't be a problem for the chiefs. Nor will it be a problem for the many folks who've gotten stupidly wealthy due to the giant paper shuffle that's occurred on the back of the equity bubble, the housing bubble and the back-and-forth between the two.
But I think that huge chunks of Americans stand a chance of being terribly disappointed in the coming years, as their retirement funds fall short of expectations. Every time I think about this (and I've been doing it a lot lately), I keep shaking my head. I'm not sure what the solution is, but I think people need to consider what the pension problem might mean for them.
Privatization: No windfall for Wall Street
Shifting from broken promises to mistaken assumptions, I'd like to discuss privatizing Social Security. Bulls believe that this proposed plan will be a one-way ticket up for stock prices. Now for the facts: The government spends all of the proceeds that come to Social Security each year. Therefore, the operating budget deficit as stated by the government is smaller than the true amount of money it actually borrows every year.
The way you can track this is to compare what the government says the budget deficit is with the weekly year-over-year change in the national debt. The government deficit figure is almost always reported at least $150 billion less than it really is. (The statistics can be seen weekly in the back of Barron's and Barrons Web site, and they are far larger now. For instance, last week the budget deficit was reported as $413 billion, yet the year-over-year increase in the national debt was $558 billion.)
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The increase in the deficit never jibes with the increase in the national debt for the following reason (and a couple others): Your Social Security contributions go to the government; the government spends the money; and the government issues an IOU to the Social Security Administration. So, the Social Security Administration is left sitting with government IOUs.
It's a bit like if youre saving for your child's education by putting money in a cookie jar. Then your wife takes it out, puts an IOU in there and spends the money at the grocery store or someplace else. When your child goes to college, you're going to have a bunch of worthless paper in that cookie jar in the form of IOUs from yourself. It's not going to get you very far.
Similarly, the government has essentially placed a stash of worthless IOUs in the form of special Treasury bonds into the Social Security trust fund. They're not, in fact, worthless, because the government can print the money to pay them off. That's what they intend to do, and that's one of the problems weighing on the dollar -- the giant size of the total unfunded liabilities of all the government programs.
A much bigger deficit
I don't think this privatization scheme will amount to anything because, as you follow the example I have given, for every one dollar that the government wants to let people keep, i.e., privatize, the budget deficit will go up a dollar. I have no idea as to the size of the program they have in mind, in terms of privatization, but to pick a couple of big numbers: If they say privatization would amount to $500 billion for privatized accounts, that means government debt will go up by $500 billion, i.e., a dollar-for-dollar tradeoff.
They're not likely to get away with that, and I don't think they necessarily should. Early indications are that the proposed changes will affect mostly young people. Can you imagine turning them loose on the market and letting them pick stocks for the long run? Didn't we already see the consequence of likeminded folly a few years ago?
In any case, this is not to imply that Social Security shouldn't be "fixed." It should be, as it's basically a busted Ponzi scheme. Somehow, somewhere, benefits will need to be cut and the whole structure will have to be looked at.
It's my sincere hope that the Bush administration can manage to solve the problem, along with some of our other problems. But the idea that privatizing Social Security is going to be a bonanza for the stock market is absolutely ludicrous.
What next for the tape?
While in stock land, I'd like to end this week's Contrarian with some thoughts on the party that has been running full tilt. It's now rather clear to me that the rally which has been going on for 18 months to two years has reached some kind of blow-off phase. This move will end in some sort of exhaustion. I must point out, though, that exhaustion is not something black and white, nor is it necessarily easy to recognize.
Could something end this move besides exhaustion? Sure, but exactly what that might be is not knowable at this point, nor is when and from where we might see the market exhaust itself (though we may be able to recognize it as it happens). All we can do is look for clues. Potential areas to watch are the price action of Google (GOOG, news, msgs) or perhaps Kmart (KMRT, news, msgs). Those would be two of my choices for gauging the speculative fervor.
Hucksters passing for heroes
One thing's for sure: We have come full circle, as folks are speculating in Internet stocks again, Morgan Stanley analyst Mary Meeker is regarded as a hero and all the discredited "New Era" types are back strutting their stuff. For the moment, it seems that pigs can fly. However, we all know that they can't.
You have to ask yourself the rhetorical question that a friend of mine posed: "If I know a plane is going to crash someday, though it might not be this particular flight, should I get on that plane?" So, those who are speculating like mad are basically saying: "I feel lucky today." That's what it's come down to. Folks expect to get lucky today, tomorrow and the next day, even though the plane they're on is definitely going to crash.
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