08 April 2013

Finding Nemo

It must be vexing to be a quant in the financial services industries. On the one hand, you're in the Next Sexy Career: data science. On the other hand, Greenspan and Bernanke and yourselves have shoved a 20 inch long 4 inch wide dildo up your yahoo. That's got to hurt.

What happened? Well, the base cause is wealth concentration. When the few have the most, there's little left to drive real demand for goods and services. Absent real demand, there's no cause to invest in real capital. With a slackening of real capital, the trickle down to fiduciary capital is inevitable. This effect is more obvious in industrial economies, over the last century or thereabouts, than earlier. But, "let them eat cake" has been the crux of the matter for a lot longer.

Unearned income is both a social and economic porcupine. To the extent that the .1%ers demand 10% or so on their amassed moolah, the quants (who are, after all, the braceros in that sector) have to find another way when Treasuries dry up. Before Greenspan cratered interest rates, it wasn't impossible to pull off. Not so much of the moolah had to find a risker home (presaging?). Treasuries were pulling in the mid to high single digits, so only a small part of that accumulated moolah had to be allocated to "risky" assets. Preferably fiduciary assets, since physical assets is something neither the .1%ers nor quants understand all that well. Physics and engineering and real demand for goods are, taken together, mind numbingly difficult to conjure.

With the Fed cratering "risk free" unearned income, the quants looked to the, historically, nearly risk free instrument: the home mortgage. Whether there was (certain Right Wingnuts gainsay) a giant pool of money out there, or not, forcing the interest rate of record to very low values forced all those who depend on unearned income to look elsewhere. So, they did. (The giant pool argument being that the rate would have cratered no matter what Greenspan and Bernanke did, since the giant pool would, in aggregate, have been chasing a fixed field of investments. Supply exceeding demand, drives down the price, which is the interest rate.)

But there is a trickle down unintended (one hopes, at least) consequence: all other forms of reliance on unearned income were just as affected. Your life insurance and health insurance and defined benefit retirement plans (the few that still exist) all began looking for ways to opt out of cratered US fiduciary assets.

What had been the earnings? Here is a compilation.

There are a slew of tables, so I'll just highlight the numbers that speak to me (from table 2.11 $millions):
1970: mortgages - 74,375 stocks - 15,420
2010: mortgages - 366,988 stocks - 1,570,225

As is obvious, a tectonic shift. Put simply: your life insurance policy now depends, more than it ever did, on Prudential's rock solid quants picking the right stocks. And more to the point: your policy depends not on compound interest, but on fiduciary capital gains. You should feel your sphincter tighten rather a lot.

Table 12.2 is instructive. There's a vicious Prudential commercial (actually, a number of versions) on the TeeVee where some "professor" has folks put a dot on a wall, representing the "oldest" person known. These are actors, of course, and it's all made up. This table has life expectancy (from the industry Bible of data; you thought each quant figured this out on his/her own? not really!) at various ages starting in 1900. At birth, it goes from 49 to 78! We're living nearly twice as long! The sky is falling! We must kill off a hoard of old people! Not really.

Social Security was established, circa 1935 (first paid 1937). So the number that really matters is life expectancy, at 65 or 75, then and now (the closest year in the table is 1939).
1939: 65 - 12.8 75 - 7.6
2009: 65 - 18.8 75 - 11.7

So, yes we are living longer, but the sky isn't falling. More to the point, since SS is a *current account* system, having folks living until 65, which is where almost all of those 30 extra years are, means more folks pay in longer. Yes, the Boomers will be something of an extra burden for a decade or so, but after that, it's all gravy.

In sum, the issue comes back to macroeconomics, despite the fact that quants operate in a microeconomic venue (what's the slickest way to make my employer richer?). Both life and health insurance are inter-generational moolah flows; that fact can't be denied. The question of equity is both micro and macro. From a micro point of view: it's a dog eat dog world, and every man for himself. In such a world, insurance is funded solely by individuals' earnings. This is a divide-and-conquer method whose main beneficiary (pardon the pun) is the financial services industry; there are a whole lot more easily divided buyers than sellers. The principle difficulty, aside from outright equity, is that individuals are cornered by the market. If one retired, or wished to do so, around 2008, with only individual assets to support said retirement, well, good luck with that.

It's simply more equitable to remove the luck (good or bad) of the draw from these decisions. Those who are eligible for funding at some point in time ought not to be penalized for macro market conditions that are cratered. Similarly, for those who are elibible at the top of the rollercoaster ride.

Any increase in retirement funding has to come from real investment. As The Great Recession proved to anyone paying attention, fiduciary instruments are merely pass-through monies. Without underlying increases in real incomes (and they can only come from increases in real productivity), the instruments fail. And so they did.

Taking a macro point of view, one comes to a somewhat different conclusion about how to fund insurance programs. Firstly, the income streams are unearned from the point of view the funds; these are fiduciary instruments which have more or less tenuous connection to real world investment. Since both retirement and health exist at the societal level, then one needn't incur the overhead costs of administering a faux investment fund. To be specific: there have been, over the years, assertions that SS is/should be an investment system. It isn't and shouldn't. It isn't because FDR's wonks weren't stupid. And it shouldn't be because it makes no sense. If SS held private stocks and bonds, how would it regulate/police the stock markets? Recall that SS came into existence in the wake of The Great Depression, which was caused by unregulated markets.

If SS held private stocks and bonds, it would be obliged, as a shareholder, to defend Enron and Country Wide and all the other malefactors of the private markets. The current system of "investing" in Treasuries (broadly defined) is a sham, and that's OK. It seems to allay some of the idiots who insist that SS holds their "personal investment". It doesn't, and never did. Also, the notion that Average American in 2010 may/will receive more than s/he paid in, is nonsense. Average American pays for the SS of his/her parents. Would you stiff Mom and Dad, just so you could have an iPhone 7? (You would?) Yes, the Boomers are the pig in the python. And yes, Boomers didn't breed as eagerly as previous generations (well, those who aren't religious whackos, anyway). But we've seen in the last 40 years that productivity has widely outpaced employment. In other words, we don't need no stinkin' babies.

That last is the political meatball. Japan put itself in the mess back in the 1990s, and China, being so much larger, is seeing the effect faster and more pronounced. Society wide insurance demands a society wide (and inter-generational) funding mechanism. Otherwise, it's let them eat cake.

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