The Great Biden YOLO

President Joe Biden pitched a pair of new federal spending and taxation bills on a scale rarely seen, intended to have transformative effects on the economy and the role of government in the economy.

The $2 trillion American Jobs Plan infrastructure spending plan includes rebuilding physical infrastructure such as roads and bridges along with federal boosts to workforce development, in-home care, and domestic manufacturing.

The $1.8 trillion American Families Plan includes targeted tax credits and education spending to benefit middle and lower earners as well as a plan to raise revenue through higher corporate taxes and taxes on higher earners and holders of wealth.

President Biden

If the twin proposals pass with narrow Democratic majorities in the House and Senate, it will herald changes of a piece and on a scale with Lyndon Johnson’s Great Society.

I’m asking myself three questions about these plans. I figure I’m unlikely to sway your fixed opinions either way, but here goes. My three questions are:

Is massive federal government stimulus spending on infrastructure a good idea right now?

Are higher taxes on corporations and wealthy households, combined with targeted tax breaks on lower earners a good idea right now?

Is increasing the federal debt by an additional $4 trillion a good idea right now?

Each of these three questions can be further considered on economic terms, political terms, and moral terms. As a citizen, I’m interested in all of these questions, on all of these terms.

Let’s start with the plan for massive infrastructure spending at this moment in the economic cycle. It’s surprising.

What I mean is that in a sluggish, ailing economy – with let’s say above 10 percent unemployment like the Great Depression or even the Great Recession following 2008 – a massive government stimulus push makes tremendous sense. That’s basic Keynesian economics. 

We’re not in that zone right now. The July 2021 unemployment rate was 5.4 percent. Yes, that unemployment rate is still worse than pre-COVID levels (3.5 percent unemployment in February 2020) but we also haven’t even fully re-opened the economy yet. 

Vaccinations, herd immunity, and the resumption of economic normalcy may naturally get us back to the relatively roaring economy of pre-COVID February 2020, without any further federal stimulus. The stock market is hitting new highs every week. (Yes, I know the stock market is not the economy, but it is a highly visible leading indicator, which is why we refer to it). Real estate prices are, in general, on fire. (Yes, housing is also not the economy, but it is an important and visible subsector of it.) And the latest GDP number was 6.4 annual growth, higher than normal trend. A massive stimulus bill right now feels, at the very least, unprecedented. I harbor strong doubts about the size and the timing of this one.

US_Unemployment
Unemployment through July 2021

What about the American Family Plan for higher taxes on corporations, higher earners, and capital gains taxes? I am here for it. I mean this more as a moral statement than an economic statement, since inequality is a leading problem of our time. But I also think it’s ok economically. First, because we need the additional revenue. Second, because the tax changes merely roll us back to times when the economy also grew strongly under higher corporate and upper income rates. Third, because tax rates and tax policy should alleviate, not exacerbate, inequality.

And the child and family support measures? I believe in expanded pre-K and community college access both morally and as an economic measure. I think poverty alleviation similarly has both moral and economic benefits, and we need to do more of those as well. We’ll be both a richer society and a better society for it.

YOLO

Finally, what about expanding federal debt by $4 trillion more right now? Phew. This is the craziest part of the conversation. A conversation that we’re kind of not even having. Republicans blew their authority and credibility on the issue of fiscal responsibility long ago. 

If Biden gets this passed, it will mark a wholly different direction than the Clinton and Obama presidencies. Despite what critics said at the time and after, the Clinton administration prided itself on shrinking government. They actually balanced the federal budget and set a course for retiring federal debt. That seems forever ago but it was merely the year 2000. In that same spirit, Obama politically hamstrung his signature health care legislation by requiring that it pay for itself and not increase the federal deficit. In hindsight, this lack of generosity probably doomed it in the eyes of the many who needed it most. 

After a career in Congress built on being a deficit hawk, Paul Ryan shepherded a unified Republican Congress and Executive Branch to pass a $1.5 trillion tax cut in 2017, a tax cut that overwhelmingly favored upper earners and corporations. This is the opposite move than a real deficit hawk would make, but Ryan just YOLOd his own reputation for those sweet tax cuts.

When the W. Bush and Trump administrations massively increased federal debt despite the Republican party’s claim to favor fiscal responsibility and limited government, Democrats seemed to have internalized a whole different approach to government debt. Democrats are no longer willing to self-limit as they did in the past. At this point they are daring the cowards and hypocrites in the Republican party to stop them.

I honestly don’t know what to think about $4 trillion in additional deficit spending. We’re in total YOLO territory. It feels like the Washington DC version of lots of things I don’t understand about money in 2021, like GameStop, Bitcoin, SPACs, and NFTs. The assumptions we long held about fundamentals and financial gravity don’t seem to hold anymore.

 “It’s different this time” are frequently called the four most dangerous words in finance. It’s been different for a while when it comes to deficit spending, as the laws of financial physics are seemingly suspended. I don’t get it. I continue to worry about gravity.

A version of this post ran in May 2021 in the San Antonio Express News.

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Paul Ryan wrecks his reputation on the way out the door

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Hey Fiduciaries: Is It All Financially Unsustainable?

money-all-goneI’ve been thinking recently about financial sustainability.  One version of the financial sustainability question is “How much can you responsibly spend from investments or endowments each year, without running out?”

There’s a lot packed into that single question, and the answers are not as esoteric as they may first appear to the average person.

Retirees living off accumulated savings, and people saving with the hope of one day living off accumulated savings, grapple with this question all the time.  Charitable foundations and institutions dependent on endowments also care deeply about this financial sustainability question, if they plan to exist in perpetuity.

But what about the rest of us, just struggling to put aside enough for whatever future expenses we anticipate – like college education for our kids, or a regular nest-egg for retirement?  Why should we care?

We should care because I suspect that the assumptions that fiduciaries[1] have made about financial sustainability in the previous generation no longer apply in the current market environment.  We have not, however, started adjusting to the new reality.  We’re not doing anything differently despite the new normal.

What does that mean?  It means that your favorite hospital or school or charitable foundation probably spends too much of its endowment every year to be sustainable.  It means your teachers and fireman and policemen – who depend on a pool of money set aside for their pensions – won’t have enough in the pool when it comes time to be paid.[2]

So, thinking about financial sustainability, I don’t think these are just the esoteric musings of a recovering banker with too much time on his hands, and too much sympathy for trust-fund folks and foundations.

The nub of the problem comes down to three facts:

1. Traditional charitable foundation/endowment spending policies[3] call for annual spending of 5% of assets,[4] as a ‘financially sustainable’ rate.

2. Traditional personal financial planning calls for annual spending of 4% of assets as a ‘financially sustainable’ rate.

3. But — riskless investments offer between 0.5 % and 2% returns.[5]

If you want complete safety with your assets, you can earn about a 1% return, which typically lags the inflation rate and puts you on a completely unsustainable path, if you have the policy of a 5% spending rate referenced in fact # 1 above.

Conversely, and axiomatically, the only way to have a fighting chance at ‘financial sustainability ’ with a 5% spending rate is to rely heavily on more risky investments, to boost the riskless 1% return to, at the very least, your 5% spending rate plus the rate of inflation.

So, a prudent fiduciary of her own money, or an institution’s money, can make the choice of taking no risk and guarantee diminishing the pool of money over time, or take a risk on more volatile markets and hope that things work out.  Which is pretty much where every fiduciary struggles right now.

I want to be very careful and point out a few ways in which what I am saying differs from the usual way we discuss this problem.

First, at the risk of breaking a cardinal rule of financial punditry, I am saying “it’s different this time.”  And by “this time” I mean “the investing life of almost everyone alive right now.”

With US Treasury Bond rates at the lowest level of most anyone’s investing life, as seen in the picture of 1953 to 2012 rates, we’re in uncharted territory for riskless returns.

Whereas previous generations of fiduciaries could choose a portfolio anchored with a large plurality of risk-free assets and cover most of their 5% spending rate, plus inflation, no fiduciary can afford risk-free assets any more.  That anchor of 1% risk-free return sinks your ship over time with a 5% spending rate.

Second, I am consciously avoiding making an argument about future return expectations.  I have no idea what future returns on risky assets will be, and I don’t intend to speculate.

It’s traditional for pension managers or endowment managers or even retirees to make assumptions about the future returns on their portfolio, to justify whatever asset allocation they do or do not wish to make.  Again, I’m not able to speculate.[6]

All I do know is that if you have to earn 6 or 7 times the annual return of riskless assets in order to cover your spending rate and inflation, then you need to fill your portfolio with almost entirely risky assets, just to break even with financial sustainability.

The only other solution, of course, is to lower your spending rate to something much closer to expected risk-less returns.  But nobody wants to take less than half the income they’re used to taking.  Or even anything less than the income they’re used to taking, for that matter.

Now it’s fair to say a version of this problem has always existed for people who manage a big pile of money for annual income but who seek financial sustainability.

What’s different now is that when 10 year Treasury bonds offered safe returns above 6% – like they did in the good ol’ days of 2000 for example – the financial sustainability choice was not so stark, or so risky.  You could count on earning most of what you needed to earn in largely risk-free assets.

Fiduciaries for educational institutions for example, face this quandary right now, all the time.  The ‘endowment norms’ from the 1960s give us cover for the idea that a 5% spending rate is prudent.  Fiduciaries know from surveys of similar institutions that they’re right in the middle of the pack, with plenty of comfortable company.  And they absolutely need that income to run the institution.

But if the norms made sense in an earlier generation of lower risk with higher return rates – – they make much less sense in the past decade – particularly in the last year with less than 2% returns for US Treasury 10-year bonds.

I don’t know what everyone should do about it.  I have no solutions.

My soon-to-retire parents hope that the previously-endorsed 4% spending rate for individuals works out.  I hope so too.  Fiduciaries for public and private pension funds hope their spending rates, return rates, and actuarial assumptions turn out to be right.  I hope so too.

My fear, however, is that from the 20/20 hindsight of our future selves, a 5% spending rate and a 1% riskless return rate look like an impossible mathematical equation that we all should have seen as unsolvable.



[1] My wife made me define this.  “fiduciary” = “person with financial responsibility for something”

[2] Which, in turn, means either: 1. Taxpayers make up the difference,   2. Retired public pensioners receive less than they were promised, or  3. Heavy inflation ‘solves’ the problem by lowering the real value of pension payouts.

[3] Based on 1960s theory about financial sustainability for charitable endowments.

[4] Charitable foundations are required to spend 5% of their corpus every year to retain their tax-exempt status.  This requirement to spend 5% of assets is probably related to where the foundation prudent practice of spending 5% came about.  But I’m guessing here.

[5] With 10yr US Treasury notes below the 2% range for the past year, the lowest in anyone’s lifetime.  Incidentally, of course some smart readers will point out that there’s a longer conversation to be had about whether US Treasury 10 year notes are truly ‘riskless,’ because if interest rates rise the bonds may decline in value before they mature, if you need to sell them rather than wait for the return of principal.  Yes, you’re right.  Other smart readers will point out that a downgraded United States no longer represents a ‘riskless’ investment.  Yes, you’re right too, up to a point.  But to the extent the US owes money on its bonds denominated in US currency, bond principal repayment is not at risk, only its purchasing power upon maturity.  All the returns I’m referring to are nominal.

[6] Fine, I’ll speculate a little bit, the following way.  If mega-bank X, which currently has the ability to borrow $ billions of dollars at 2%, had any comfort at all with a safe way to earn, say, 7% in risky assets, then mega-bank X would be doing that trade for a 5% positive carry (the difference between borrowing costs and earned return) all day long.  The fact that 7% in risky assets seems, well, risky, tells you a little something about return expectations from the smartest minds in the business.

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