Tag: Kent Smetters

Not Ready to Retire

Posted on February 5, 2013

828023.TIFThe American dream of working three or four decades and then retiring to a life of well-earned comfort is no longer an option for a surprisingly large number of workers.

According to a new report from The Conference Board titled, “Trapped on the Worker Treadmill,” people between the ages of 45 and 60 who have experienced a job loss, seen their salary reduced or watched the value of their home decline are “much more likely” to consider delaying retirement. More specifically, The Conference Board states, “of respondents aged 45-60, the percent that plans to delay retirement has gone up 20 percentage points in two years.”

This is despite a much-improved economy – including higher housing prices, an upswing in the stock market and increased hiring.

“It’s disconcerting that the two years in which the U.S. economy seemed to finally, if fitfully, turn the corner also left so many more workers compelled to change their retirement plans late in their careers,” says Gad Levanon, director of macroeconomic research at The Conference Board and a co-author of the report, in a quote on the association’s website. “This may benefit some businesses and industries, by reducing labor shortages and skill gaps as experienced workers stick around. At the same time, their delaying retirement can be a significant obstacle to the many companies seeking to cut costs.”

A major factor contributing to the survey’s findings “is the continued depletion of savings,” according to The Conference Board website. “The U.S. recession officially ended in July 2009 and the stock market has rebounded strongly since then. In 2012, however, 62% of 45- to 60-year-olds reported at least a 20% decline in the value of their financial assets since the start of the crisis — up from 42% in 2010.”

“People are finally realizing that living to 120 (which the actuaries are forecasting) is going to be very, very expensive,” notes Olivia Mitchell, Wharton professor of business economics and public policy. “Accordingly, a few more years of work can provide the degrees of freedom many need to offset declines in housing values and 401(k) account balances. Also, medical care costs are going through the roof, which is enough to make many think twice about leaving jobs with health insurance coverage. And finally, the recent research suggests that working longer makes for healthier lives, which may be quite attractive to many.”

Kent Smetters, Wharton professor of business economics and public policy, agrees. “Probably only about a third of baby boomer households have an adequate amount of saving for retirement anyway,” he says. “Of course, part of the reason might be that many people have been out of the market and have not enjoyed recent stock returns. Another reason might be a general fear of risk. But one reason might simply be that as more people approach retirement, they are finally looking at the numbers and simply realizing that they never saved enough in the first place. Most have not.” 

Related to this, Smetters adds, is that “in the old days of 5% interest rates, people used to think that retiring with a million dollars was adequate, because they could safely get $50,000 per year without dipping into their principal. They now realize that they need a lot more since interest rates are so low.” 

Wharton management professor Matthew Bidwell wonders about one of the report’s numbers. “Hopefully, people who are 45 are not planning to retire imminently, so this is not necessarily a comment on their immediate situation, but rather it is tapping into a broader set of beliefs about how their lives will play out,” he says. “It may reflect a general erosion of trust in the ability of the current set-up, in terms of savings institutions and entitlements, to provide for them as they retire.” 

The report’s findings also raise the issue of whether more and more young people are being kept out of the job market – and delaying their own careers — because older people are hanging on longer. Not necessarily, says Bidwell. “I think economists would argue that people who are delaying retirement are doing so in order to earn, and spend, more money than they otherwise would be able to. That spending money ultimately creates jobs.” 

Adds Mitchell, who is also executive director of The Pension Research Council: “The idea that there is a fixed number of jobs has long been discounted by economists. Rather, the labor market tends to be very flexible, so the prediction is that more older workers will [likely] be absorbed relatively easily. In fact, in countries which encourage earlier retirement ostensibly to ‘make way’ for the younger folks, it proves to be very expensive to pay for all the retirement benefits. [Then] tax rates rise so much that it discourages younger employees from working.” 

Which industries are likely to benefit more than others from this trend of delayed retirement? “Probably the industries in which customer care matters – retail trade, service sector – where older employees tend to be more polite, patient and have better phone manners” than younger employees, says Mitchell.

 

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Faculty Perspectives on the Election

Posted on November 7, 2012

In the wake of President Barack Obama’s victory over challenger Mitt Romney in the 2012 presidential election, K@W Today asked Wharton faculty for their perspective on a number of issues that will take center stage in the days and months ahead.

We posed a number of questions, including:

  1. What do you think was the biggest reason for Romney’s loss? What should he have done differently?
  2. What was the biggest reason for Obama’s victory?
  3. An editorial in The Wall Street Journal suggested that Obama got a big boost in the election from two men: Ben Bernanke and his quantitative easing, and John Roberts, who joined four other Supreme Court justices in upholding Obamacare. Do you agree?
  4. The election raised interesting demographic questions. Romney appealed to many white males, while Obama appealed to many Hispanics, Asians, women and African Americans. Does this suggest that Republicans need a better strategy to attract these groups going forward?
  5. What should Obama’s strategy be for dealing with the key issues of unemployment, the fiscal cliff and the deficit?
  6. Is there any reason to think that the Republicans, who control the House of Representatives, will be more willing to work with Obama to get some of these issues resolved? Can the two parties hope to work together?

Here is what we heard:

Peter Cappelli, director of Wharton’s Center for Human Resources:

“Aside from the tactical issues, the fundamental issue in the election was the role of government. The vote was basically split between those who did not think government did much for them economically and those who thought government either did, or should do, something for them. The Democrat/Republican divide always reflects this issue, but it was much starker this time because the Republican position was more extreme, particularly in the proposed cuts for social services.

“The Romney campaign suffered because its proposals seemed to frighten too many voters who feel they need government protection. The Romney ticket also could not shed the baggage from the primaries on social issues – women’s rights and immigration, in particular – that hurt them with those voters.

“The biggest reason for the Obama victory in my mind was that Governor Romney’s various gaffes shifted the contest from being a referendum on President Obama and the poor state of the U.S. economy to being more of a referendum on Governor Romney. Much of the energy on the Democratic side seemed to be [directed] to voting against the Romney ticket.

“There are a hundred things that made a difference to the election. Certainly if Obamacare had been turned down by the Supreme Court, things would have been bad for the President, but then it was bad for the Democrats when the Supreme Court upheld Citizens United. Quantitative easing appears to be helping the economy, but it has been bad news for the President that none of the other treatments before helped much. A lot of other things could have gone differently that would have affected the outcome….

“The big question seems to be how the Republican party, especially in the House of Representatives, will see their effort over the last four years to obstruct anything that would appear to give the President a legislative victory. The goal of that approach was to prevent the President’s reelection. That did not work. So what do they do now?”

Mark V. Pauly, professor of health care management:

On why Romney lost: “The economy recovered enough to take away his main argument for change.”

On The Wall Street Journal editorial: “I do not see that the court decision on health care reform meant more votes for the President. It kept an issue alive — you need to vote Republicans [into office] to get rid of Obamacare — but that was obviously not an important enough issue, nor should it have been since in the short run, relatively few people gain or lose from health care reform.”  

On dealing with the issues of unemployment, the fiscal cliff and the deficit: “Republican control of the House of Representatives will keep us at the same point in discussing these issues as we were before the election.”

On whether the two parties can work together: “Now that the House knows it will have to deal with the President, I expect they will try to get some things resolved that were held hostage to the election. I think the President has used most of the ammunition he has in terms of executive orders and the like, so I expect the House will pull things their way. We will have some tax increase on millionaires and billionaires, but of course we do not have enough [of them], so that will not help the deficit that much. It will just make Democrats feel better.

“I am hoping this will set the stage for bipartisan tax reform along the lines of the Rivlin-Domenici or Bowles-Simpson [debt reduction plans]. Both have big health care parts to them. I think the election gives cover to Republicans to go along a little.”

Kent Smetters, professor of business economics and public policy:

On why Romney lost and Obama won: “Obama had a better ground game — more regional offices, more effort to get out the vote. Romney also focused solely on jobs without painting a broader picture. He should have channeled Reagan a bit more.”

On The Wall Street Journal editorial: “I don’t agree with it. Money injected by [the third round of quantitative easing] is basically just sitting on bank balance sheets. I think that the [Supreme Court decision on health care], if anything, helped mobilize conservatives behind Romney.”

On the demographics question about Obama’s popularity with minorities: “The election raised interesting demographic questions. Romney appealed to many white males, Obama to Hispanics, Asians, women, African Americans and other ‘minorities.’ Does this suggest that Republicans need a better strategy to appeal to these groups going forward? Romney also appealed to married females. But, yes, the Democrats are effective at class war politics. Republicans need to do a better job of explaining how prosperity is better than envy.”

On a strategy for dealing with unemployment, the fiscal cliff and the deficit: “The ‘fiscal cliff’ is a horrible term. Minus five for Bernanke for coming up with it; minus 10 for still being an old school Keynesian. Otherwise, I like him.

“The real cliff is if we keep focusing on the short run without also addressing the huge budget deficit. The problem with the U.S. economy is not the lack of consumption. We have plenty of it. The problem is the lack of investment. We need to address the fiscal cliff by removing some of the uncertainty about future tax rates and returns to investment. Any proposed solution to the fiscal cliff can’t be short-term and [can't work without] comprehensive reform of the tax code and spending side that improves the long-run situation as well.”

On whether the two parties can work together: ”No, they will continue to play chicken. Hopefully, however, it will lead to a grand compromise, like the 1986 Tax Reform Act where Reagan and the House Democrats hammered out a deal that was tenable to both sides.”

Mark Duggan, professor of business economics and public policy:

On why Romney lost and Obama won: “A key reason for Obama’s victory is that the economy has been gaining more momentum over the last few months, with unemployment falling below 8% and job creation relatively strong. This may have given voters more confidence that his policies, such as his help for the auto industry — an important issue in arguably the most important state of Ohio — were working. His handling of Hurricane Sandy also probably helped to give him just a bit more support so that he pulled out wins in pretty much all of the states that were deemed battlegrounds.

“While Florida has still not been called, the races in states like Ohio, Virginia and Colorado were sufficiently close that even a small boost might have helped lead him to victory. Plus his victory margins in Wisconsin, Iowa, New Hampshire and Nevada were somewhat bigger than expected. On the foreign policy front, I think most people felt he won the third debate; that may have helped to tip the balance for many voters, too.”

On issues like the fiscal cliff, taxes and unemployment: “As for big things that are coming down the pike, the President will be negotiating with Congress on what to do about the upcoming fiscal cliff. Effective January 1, 2013, there are a set of spending cuts and tax increases taking effect that will lower the deficit by about $600 billion, which is close to 4% of GDP. While reducing the deficit is important, many think that a change in government policy of this magnitude could put the economy back into recession. Thus, it will be very important for Obama to work with Congress to make the right tradeoff between starting to tackle the deficit and stimulating economic growth.

“Certain parts of the fiscal cliff, like the payroll tax holiday (a 2 percentage point cut in this tax for all workers on their first $115,000 in earnings), are very unlikely to be renewed, but others — like the spending cuts and increases in income taxes — are likely to be negotiated. Long-term deficit reduction is also hugely important, with changes needed to the tax code and to entitlement programs.

“The fact that Obama will now be a second-term President may make it easier for him to confront these challenges as he does not need to worry about being re-elected. Indeed, that is why many support term limits.”

 

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A Lost Generation’s Big Drop in Family Wealth

Posted on June 18, 2012

The Federal Reserve last week documented just how steeply family income across the U.S. has fallen, and the figures aren’t exactly uplifting.

According to the Survey of Consumer Finances (SCF), done every three years, the median value of family income fell by 7.7% between 2007 and 2010, from $49,600 to $45,800. Meanwhile, median net worth fell 38.9%, from $126,400 in 2007 to $77,300 in 2010 — a reflection of the severe downturn in the housing sector. The last time net worth was this low was 1992.

But the news isn’t all bad. As Wharton business and public policy professor Jeremy Tobacman points out, “This was a terribly serious decline, which has already reversed direction. Remember, the unemployment rate barely began to fall before the start of 2011. Since then, it has fallen slowly but fairly steadily.” He cites the Federal Reserve’s own release about the SCF findings, which states that: “The vast majority of interviews for the 2010 SCF were completed in 2010, but some were completed in early 2011. Thus, the survey data are largely unaffected by changes in economic activity since 2011 — in particular, the rise in the market price of corporate equities, the relative stabilization of house prices, and the start of a decline in the unemployment rate.”

Tobacman suggests that while “these numbers remind us just how terrible the Little Depression has been, they [also] simultaneously impel us to remember that the economy has been improving over the last 18 months.” At the same time, however, “one other fact leaps out from the report, especially during an election season [where] fairness is a touchstone issue: Even at the end of the boom in 2007, half of U.S. households earned less than $49,600 per year.”

Wharton business and public policy professor Kent Smetters also tempers the discouraging report, noting that “most of the decline is the reduction in housing wealth, which is less serious than if it were a reduction in non-housing assets. Non-housing assets are mainly used for putting kids through college, paying down debt, [covering] emergencies, retirement and so forth. So a loss of non-housing wealth can produce a material impact on lifestyle. However, for housing wealth, one’s lifestyle is mainly impacted to the extent that the family was intending to downsize and consume the difference in housing values. To be sure, that happens. But it is less important than a loss in non-housing wealth.”

Nonetheless, he adds, “the reduction in even housing wealth is significant simply because the average American family has so little non-housing assets available. Any loss, even to non-housing assets, becomes important.”

As for whether the decline will reverse itself anytime soon, “It’s very hard to say,” Smetters notes. “The large government deficits certainly don’t help because they will likely translate to lower future after-tax income.” It’s also hard to predict what will happen to home prices.  

His advice to the powers that be in Washington, D.C.? “Spend less.”

Meanwhile, what economic group in the U.S.has been hardest hit by the decline in family income? According to a recent article in the Philadelphia Inquirer titled, “A Generation in Collapse,” Generation X – those who entered the workforce in the late 1980s and early 1990s – “got more scorched than anyone else.” As the article notes, Gen Xers “have been decimated financially at a fragile time, while forming households and raising young families, those ordinary coming-of-age endeavors.” Their median net worth in 2010 was less than half the net worth of those who were their age in 2001 — $42,100 vs. $95,100.

In addition, the article points out, “due to little more than the bad luck of birthdays, a higher proportion of Xers purchased homes while prices were exceptionally high.”  Couple that with the fact that home equity decreased 42.3% between 2007 and 2010 – from $95,300 to $55,000 – and it’s easy to wonder how “this Lost Generation [can] even start to catch up, considering the grim pace of economic recovery.”

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A Good Deal, for Whom?

Posted on February 13, 2012

After months of wrangling, the government last week announced a $26 billion settlement with five of the country’s biggest banks that is designed to offer some relief to homeowners victimized by fraudulent mortgage practices and foreclosure abuses.

The five banks include Bank of America, JPMorgan Chase, Citibank, Wells Fargo and Ally Financial.

The goal of the settlement is to hold the banks accountable for a range of shady dealings — ranging from charging new homeowners excessive fees for insurance policies to evicting current homeowners on the basis of unsubstantiated or false information — and also to jumpstart the moribund housing market.

Observers, however, are skeptical about who this settlement will really help. Some say the banks have gotten off easy even as relatively few homeowners will be helped by the promised aid. A column in Sunday’s New York Times business section, for example, suggests that the payback to people whose properties were wrongly foreclosed on will most likely be less than $2,000 per homeowner. The column also describes the settlement as a “stealth bailout of the major banks” because, as one critic points out, “it will improve the value of the second liens or home equity lines of credit [the banks] own” because these holdings are “worthless if the first mortgages preceding them are underwater.”

Nor is there any expectation that the banks will actually carry through on the promised compensation, the column goes on to say, citing other agreements with the government — such as Countrywide Financial’s predatory lending settlement in 2008 — in which banks failed to live up to the terms of a deal.

Finally, skeptics doubt that the mortgage industry’s reputation will be rebuilt after an agreement that offers too little, too late to help either individual homeowners or the overall housing market.

According to Kent Smetters, Wharton professor of business and public policy, “The agreement ostensibly deals with alleged acts committed by banks during the foreclosure process, including improper papering and fees. However, the remedies in the agreement itself use broad brush strokes that do not sufficiently target the harmed parties, instead benefitting some homeowners who simply borrowed more than they can repay. It is not surprising, therefore, that the help is diluted.”

The real problem, he adds, “is not the total size of payments, but a banking system with insufficient accounting systems and securitization processes that render targeted remedies nearly impossible.”

Wharton real estate professor Susan M. Wachter describes the deal as “a start, a down payment, if you will. It covers only a small share of the market. But for those it helps, it will matter. And it may help put into place a template for solving the far larger part of the problem that is out there.”

Indeed, an article last week in The New York Times notes that the money “will help a relatively small portion of the millions of borrowers who are delinquent and facing foreclosures,” but adds that the agreement remains “the broadest effort yet to help borrowers owing more than their houses are worth.” It predicts that about one million people will be able to get their mortgage debt “reduced by lenders or will be able to refinance their homes at lower rates.”

In addition, the article states, the settlement does not preclude regulators from filing criminal charges against banks or investigating other questionable practices related to the housing market, such as insurance and tax fraud or the bundling of risky mortgages into securities later sold to unsuspecting investors.

 

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A Primer for the Protesters?

Posted on October 7, 2011

The “Occupy Wall Street” movement that started in New York and is moving into major U.S. cities aims much of its anger at the greed and hypocrisy of big U.S. banks. What isn’t clear, however, is exactly what the protesters would like to see changed.  

At least that is how New York Times columnist Nicholas Kristof sees it. In an opinion piece on Sunday, Kristof compared the protesters to their counterparts in the Arab Spring movement earlier this year. “There is a similar tide of youthful frustration with a political and economic system that protesters regard as broken, corrupt, unresponsive and unaccountable,” he writes, going on to say that while he does not share the “anti-market sentiment” of many of the protesters, he does think that during the last few years, “banks got away with murder. It’s infuriating to see bankers who were rescued by taxpayers now moan about regulations intended to prevent the next bailout.” 

As for the protesters, where the movement “falters,” Kristof says, is “in its demands. It doesn’t really have any.” To fill the gap, he offers the following suggestions.

The first: Impose a financial transactions tax. The second: Close the “carried interest” and “founders’ stock” loopholes, which he calls perhaps the “most unconscionable tax breaks in America.” And third, protect big banks from themselves by moving ahead with Basel III capital requirements and adopting the Volcker Rule to limit banks’ ability to engage in risky and speculative investment. He also endorses a proposal already embraced by Obama and others that would institute a bank tax based on an institution’s size and leverage.

KnowledgeToday asked Kent Smetters, Wharton professor of business and public policy, to review and comment on Kristof’s suggestions. As it turns out, he agrees with some of them.  For example, he thinks Basel III is “a modest step in the right direction. But I actually would modify the details so that the capital reserves required of systemically important institutions are tied to better measures of risk, including credit default swaps.”

He would “generally oppose a simple transaction tax — a very klutzy way to deal with a real problem about transparency and accountability of counterparty risk. Instead, I would require that most financial transactions occur through an exchange or clearinghouse so that a private third party, with a stake in the game, does the risk management. In contrast, a tax is an indiscriminate grenade that inflicts pain on both bad and good transactions. To use another metaphor, don’t use a sledgehammer to do CPR.”

He is not sure what he thinks about carried interest because “it really depends on whether we think that carried interest is in lieu of wages (that would normally be taxed at the ordinary rate) or forced investments from wages (that would normally be taxed as capital gains). Answering this question is part of my active research, and I don’t know the answer yet. But, I am fairly confident that Kristof does not know either, at least not enough to justify the hyperbole.”

He disagrees that a loophole exists with regard to founders’ stock. “In particular, founders’ stock [sometimes called restricted stock] is taxed at the capital gains rate because it is a long-term investment that is taken early. To be sure, it could be argued that the par price — how much a founder pays for the stock — is fairly arbitrary and too low. But the entire gain relative to that purchase price is still taxed as a capital gain, which is consistent with most long-term investments. Moreover, stock options, which are usually granted later, are taxed as ordinary income since they are not purchased upfront.”

So while he agrees that there is a legitimate debate about carried interest, “I think we should leave founders alone and let them innovate. Taxing founders above the capital gains rate strikes me as about as sensible as having a tax on sidewalk squatters.”

Jack M. Guttentag, an emeritus professor of finance at Wharton who runs a website called The Mortgage Professor, notes that all of Kristof’s proposals, “whatever their merits or flaws from a structural standpoint, are deflationary and will make the current economic situation worse.” His focus now is “the depressed housing market and the depressed economy, and the two are closely related.”

Guttentag argues that “Fannie Mae and Freddie Mac, which are now in a Federal Government conservatorship, should roll-back their lending terms to where they were before the financial crisis. This would prevent a second round of home price declines, and, in addition to benefitting homeowners and the economy, would reduce Fannie/Freddie losses, which makes it a requirement of responsible conservatorship.”

 

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Retirement Heist? Pensions, Past and Present

Posted on September 19, 2011

In a book published last Thursday, Retirement Heist: How Companies Plunder and Profit from the Nest Eggs of American Workers, Ellen Schultz, a reporter for The Wall Street Journal, analyzes how large companies — along with the whole retirement industry, ranging from benefits consultants to life insurers — have been bilking American workers out of the health benefits and pensions they have earned during years of employment.

“A little over a decade ago, most companies had more than enough set aside to pay the benefits earned by two generations of workers, no matter how long they lived. But by exploiting loopholes, ambiguous regulations and new accounting rules, companies essentially turned their pension plans into piggy banks, tax shelters and profit centers,” according to a description of the book on Amazon.com, which goes on to note that the damage isn’t limited to any one group: “Employees of all political persuasions and income levels — from managers to miners, pro-football players to pilots — have been slammed.”

Olivia S. Mitchell, executive director of Wharton’s Pension Research Council, notes that “during the 1980s, many corporations benefitted from the run-up in the stock market, and prominent firms, A&P being one, terminated their defined benefit plan, took the excess assets and ended up plowing them back into the company to upgrade the stores. A&P was the one that got a lot of attention because it was in conjunction with its purchase by a German supermarket chain. So there was a lot of discussion over whether this should be allowed.”

U.S. law, Mitchell says, “still permits some asset reversion of this type, although there are now penalties associated with overfunded termination. This naturally has really put a damper on reversion of excess assets. Also, most defined benefits plans are now underfunded.”

Even more important, Mitchell notes, has been the fairly rapid transition away from defined benefit plans toward 401(k) plans, partly because of a massive change in the labor market. “Employees come, stay for a short time and leave, and they are frankly not interested in a defined benefit plan with a 30-year to 40-year time horizon.” At the same time, many employers, like IBM, are also not interested in the defined benefit model. “They want turnover so they can get the newest, most frontier-trained engineers and software experts available.”

Kent Smetters, Wharton professor of business and public policy, agrees that “many of the changes in the private plans have reflected shifts away from defined benefit (pension) plans to defined contribution plans as a way to support greater mobility of the workforce. Traditional pensions are mainly compatible with jobs where people work at the same employer for most of their work life. They are hard to transport between jobs. The defined contribution model allows for that [rollover]. It is true that some companies potentially reduced benefits in the transition as they directly converted their defined benefit to defined contribution plans. But many of those conversions were ruled illegal or frozen.”

Most companies, he adds, “simply keep the defined benefit plan open for existing workers covered by that plan and require new workers to use the defined contribution plan. The employer then usually makes some contribution to the defined contribution account, either as a match and/or straight (unmatched) contribution. In fact, non-discrimination IRS rules for qualified plans heavily encourage employers to contribute to the defined contribution plans in order to ensure enough participation by less compensated individuals.”

Asked about the conclusions presented by Schultz’s book, Smetters suggests that “the largely unregulated state and local public pension plans played lots of games. The real wholesale shame here [has been] with those plans, not the private ones.”

Another factor to consider in this discussion, says Mitchell, is that the U.S. government backs defined benefit plans through its own insurance agency, The Pension Benefit Guaranty Corp. PBGC “charges a premium, which has had to be boosted because of the underfunded status of American defined benefit plans. It is a vicious circle. If you have a plan and you are underfunded, then the plan is backed by the government insurance company, so there is relatively little incentive to fund it. And if you are thinking about starting a new defined benefit plan, heaven forbid you should take on the legacy costs that all the other companies are likely to impose on this insurance entity.” In fact, these days only very small employers — those with 20 or 25 employees, typically law firms, medical partnerships, etc. — have defined benefit plans because such companies are not required to pay into PBGC.

In Retirement Heist, author Schultz documents hardship stories of individuals who were denied the retirement benefits promised to them by their corporate employers. These cases might typically be ones “where companies have underfunded pensions, and the government only provides a basic guarantee,” says Mitchell, adding that these guarantees are hardly “six figure pension payments. I remember during the mid-1990s when one of the airlines went bankrupt, and its pilots were expecting $120,000 or $130,000 in corporate pension benefits. It turned out that the maximum benefit that PBGC would pay them was about $25,000.”

What has Mitchell and many others worried is that neither Social Security nor Medicare are in good financial shape, even though both are the cornerstones of retirement security. “The lack of attention at the federal level to fixing them is a grievous situation,” says Mitchell. “The current jobs proposal has a continued reduction in the payroll tax, in fact a greater reduction than was implemented last December. While I can understand the impetus for a stimulus, this does hasten the day when both programs run short of money.”

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Labor Day 2011: Not Everyone Will Be Celebrating

Posted on September 2, 2011

If you look up the words “Labor Day” on the web site of the U.S. Department of Labor (DOL), you will learn that this holiday — first celebrated on September 5, 1882, in New York City — “is dedicated to the social and economic achievements of American workers.” The labor force, the site notes, “has added materially to the highest standard of living and the greatest production the world has ever known…. It is appropriate, therefore, that the nation pay tribute on Labor Day to the creator of so much of the nation’s strength, freedom, and leadership — the American worker.”

Unfortunately, for 9.1% of these lauded American workers, Labor Day 2011 finds them without a job and, in some cases, with little hope of finding one soon. The economy continues to limp along two years after the financial crisis, and most economists don’t expect the employment situation to improve until the end of 2012, at the earliest. Department of Labor figures released on September 2 piled on more bad news: Not only did the  unemployment rate remain unchanged for the month of August, but no new jobs were added to the economy despite expectations that the figures would show some improvement.

Acknowledging the importance of jumpstarting the economy and getting people back to work, President Obama plans to lay out a jobs agenda in a speech to Congress on Thursday.

KnowledgeToday asked several Wharton professors to each propose one idea for getting people back to work.

Peter Cappelli, director of Wharton’s Center for Human Resources and professor of management: “The most successful government policy for encouraging jobs is hiring subsidies — programs where the government gives employers some kind of subsidy for each new hire they make, usually in the form of a tax break of some kind. There has been extensive research on these programs, especially in Europe where they have been popular, and they work better than anything else at promoting new jobs. They have been tried in various forms in the U.S., mainly to help disadvantaged workers get into the labor market, but they were also used after the 1991 recession to promote hiring. While the results have not been spectacular, they are better than any other option under consideration.”

Mauro Guillén, director of the Joseph H. Lauder Institute and professor of management: “There are two types of unemployment — long-term and short-term. It is impossible to design effective policies that do not distinguish between the two. Long-term unemployment includes people whose jobs (or even industries) have disappeared. These people need re-training, and they need to be reminded that there is a place for them in the global economy, because otherwise they will feel discouraged and drop from the labor force. Therefore, education and training policies are needed.

“Short-term unemployment is a different story. It affects workers who have the skills to play a role in the global economy, but are jobless because of the economic downturn. The policies needed to tackle this type of unemployment all have to do with accelerating GDP growth. The debate among politicians, policymakers and academic economists is about the best way to stimulate the economy so that it creates jobs. Some argue that lower taxes, less regulation and a balanced budget is the way to go. Others maintain that the economy needs a boost in order to start growing in a sustainable way, so cutting government programs is not appropriate because aggregate demand will suffer. It is also important to keep in mind that the lingering doubts about the banking sector and the continued lack of confidence and trust in financial markets is adding to the problem because credit is not flowing to businesses as it should.

“As an aside, I think long-term unemployment among the young is the most disturbing aspect of the present economic situation. This problem is not as severe in the U.S. as it is in Europe and in the Middle East (hence the Arab Spring and the protests in the U.K., Spain, and elsewhere). Still, youth unemployment poses its own set of policy issues. A mix of education, training and economic growth is needed.”

Peter Linneman, emeritus professor of real estate: “The answer is reduce political risk. The government has been awash in new and unformed regulations and interventions for three years. There are no predictable ‘rules of the game.’ To that end, announce that taxes will not be changed in any way for five years, and there will be no new regulations introduced for three years. Give predictability a chance.”

Kent Smetters, professor of business and public policy: “I would focus on removing the distortions that companies currently face when making business investments.

“Under current law, the cost of a business investment can be used to reduce reported taxable income according to (usually) a straight-line depreciation schedule (with some modifications). For example, if I bought a machine for $100,000 that is projected to last for five years, I could report $20,000 in expenses against my business income over each of the next five years. Instead, I would move immediately to a tax system that allows for ‘full expensing’ of all business investments. In other words, all $100,000 would be immediately deductible against current income, regardless of the life of the asset. This idea dates back to the late, great Princeton economist David Bradford, during his time at Treasury under Ronald Reagan, and it has been supported by some prominent Democrats in the past as well, including [former senator] Tom Daschle. Full expensing would encourage the private sector to stimulate investment without the government trying to pick winners and losers. To be sure, full expensing is costly; it would likely cost the Treasury up to $1.5 trillion over the next 10 years. But it could be cheaper than all of the other stimulants and command-and-control methods currently being used by the Administration.”

Susan Wachter, professor of real estate: “Bring stability to the housing market. Consumer confidence is at all time lows. Construction and construction jobs are at record lows. Buyers are sidelined in what is the most affordable market in history. Ironically, this requires long-term thinking. Buying and putting equity at risk is not in order when buyers are worried about what the future holds. We need to build consensus on the provision of housing finance going forward. This is a large segment and the most underperforming segment of our economy. We need certainty to replace the fears of what is to come.”

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Why Standard & Poor’s Downgrade of U.S. Debt Was a No-brainer

Posted on August 12, 2011

Don’t shoot the messenger whose August 5 downgrade of U.S. debt set off the turmoil that rocked world markets this week. Standard & Poor’s had ample reason to lower its rating of long-term U.S. Treasury bonds from their top AAA rating to AA+, says Wharton finance professor Richard J. Herring.

The S&P downgrade was in some ways a no-brainer, according to Herring. “After the political spectacle [in Congress] over raising the debt limit, it is hard to argue that the U.S. is in a stronger position to repay its debt than it was a year earlier,” he says. “S&P had very clearly stated its concerns and the amount of fiscal reduction it felt necessary to maintain the AAA rating, and the last-minute deal simply didn’t make the mark.”

Indeed, S&P focused on Washington’s dysfunctional politics in the agency’s downgrade report. “The political brinkmanship of recent months,” said the agency, “highlights what we see as America’s governance and policymaking becoming less stable, less effective and less predictable than what we previously believed.”

Among other key points with regard to the historic downgrade:

S&P could soon have company. While S&P is currently the only major credit agency to downgrade U.S. debt, that may change before long. “It’s not obvious that Moody’s or Fitch will maintain the AAA rating,” says Herring. “Both are reconsidering their current rating.” A smaller agency called Egan-Jones lowered its own rating of U.S. debt from AAA to AA+ in July.

The three major rating agencies have credibility when rating government debt. S&P, Moody’s and Fitch have been much better at evaluating government debt than their failure to spot the risk of subprime mortgages during the housing bubble might indicate. “In that case, the rating agencies got it wrong for a huge, important class of securities,” notes Herring. “That’s not true with regard to sovereign debt,” he says of bonds issued by national governments. Agency ratings of such debt “have been relatively good — though far from perfect,” he adds.

S&P’s $2 trillion error was hardly material. The agency initially underestimated the projected long-term impact of the Congressional debt-cutting deal by $2 trillion. “But $2 trillion in terms of the grand scheme of things is a small number,” says Wharton emeritus finance professor Marshall E. Blume. For example, the Congressional Budget Office estimated in January that if current spending laws remained in place, federal debt would grow from 70% of this year’s $14.5 trillion Gross Domestic Product to 190% of the GDP in 2035. Looked at another way, the present value of the federal government’s funding shortfall for Medicare, Medicaid and other programs now exceeds $100 trillion, notes Wharton business and public policy professor Kent Smetters. (Present value estimates what the sum of a future stream of money would be worth today.)

U.S. Treasury bonds have been higher since the downgrade. The price of 10-year Treasuries has climbed and yields on the bonds, which fall when prices rise, hit near-record lows before gaining a bit on Thursday. Treasury debt “still looks good relative to other assets,” says Herring. None of the remaining countries with AAA ratings “have a sufficient quantity of debt outstanding to provide an adequate substitute for large holders of dollars.”

The impact of the downgrade could have been much worse. In a prescient move, regulators did not require financial institutions to adjust their books to reflect the downgrade. This would have clobbered bank balance sheets by forcing them to put up more capital against their vast holdings of Treasury securities, experts say.

Overall, the downgrade serves as a wakeup call to Washington. “S&P is predicting that there is now a non-zero chance that the U.S. could default on its debt in 10 or 20 years,” says Blume. S&P further warned that the agency could lower its rating to AA within the next two years if there is less debt reduction than Congress agreed to.

Any default would be a matter of choice rather than necessity, since the U.S. could always print more money to meet its obligations. “It’s very easy for the U.S. to avoid a default,” says Blume. But Washington might not accept “the inflationary pressures that would go along with the printing of money.”

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