Irony on the Left

Being a Life Actuary, I have been painfully aware of the prolonged low interest rate environment for some time. And given that Bernanke and his likely successor as Chair to the Federal Reserve, Janet Yellen both subscribe the Keynesian school of economic thought, there are some who feel low interest rates will be around for some time.

For those of you who haven’t been keeping score at home, Keynesianism holds that high interest rates are bad. High interest rates encourage saving that locks down money that should be being spent, and also discourages borrowing which would enable the purchasing of new homes, etc. In order to keep interest rates down, the Fed borrows about $85 billion a month to buy US Treasuries. Like all things in the world of supply and demand, the more things are demanded and bought, the higher the price goes. And as anyone who has taken a course in finance will tell you: the higher the bond price, the lower the interest rates.

For those of us who’ve refinanced a home, moved, or even bought a car in the last 5 or so years, these lower interest rates are awesome and have made it much easier to make these big purchases; which of course help the economy. Those of us who work in the financial sector of the economy think these low interest rates suck (that is an actuarial term).

From here I am going to use a broad brush to paint the ironic contradiction I alluded to in the title of this blog. Generally speaking, economists in favor of Keynesian policies tend to be more liberal. I would also generalize that union support is also a liberal platform. The irony can be seen when realizing that one of the most beloved union benefits, the defined benefit pension, is killed by low interest rates. Pensions as a benefit are very attractive yet are becoming more and more rare. In the simplest form, a pension is a guaranteed income based off of your final salary (or average of several years of final salary) times a percentage per year of service. The employer is required to fund these pensions while the worker is employed; with the level of funding and contribution method being defined in the plan. The funding level each year is an actuarial calculation that takes into account assumed future salaries, terminations, deaths, years of service, retirement age election, etc., and present values those benefits. As with all actuarial calculations, when interest rates go down, the present value of future cash flows go up (I originally attempted to throw in some actual formula’s but thought I’d be kinder to my readers.) So while Keynesianism is winning out as the practiced economic policy for several terms running, pensions are taking it on the chin.

So while its fun to vilify the politicians around Detroit's Pensions and to demonize Scott Walker, it should be noted that regardless of the ancillary issues going on, there is no way around that pensionless workers are laying in a bed made my leftist economic policies.