financial markets in 2013

7/30/2019 Financial Markets in 2013

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Financial Markets in 2013:

Where are the Stories?

Strictly Financials

Saturday

January 5, 2013


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Strictly Financials 2

Donald W. Reynolds National Center

for Business Journalism

at Arizona State University


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n Gary Trennepohl, Ph.D.n ONEOK Chair and Presidents Council Professor of Financen Oklahoma State Universityn Trustee, Oklahoma Teachers Retirement Systemn Member, OSU Foundation Investment Committee

[email protected]


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THE EVOLVING STORY OF THE FINANCIAL CLIFFAND REVISING THE U.S. TAX CODE

SOCIAL SECURITY AND MEDICARE

HOW UNDERFUNDED ARE PUBLIC WORKERSPENSIONS?

SURVIVAL OF THE EURO AND THE EUROZONE

Major Economic Themes for2013



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What is the Fiscal Cliff?

n The Mix of Expiring Tax Cuts andSpending Reductions that, if we go overthe cliff, could lead to a double dip

recession.



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Why Something Must Be Done

n The economy is weak, so any reductionin demand it is feared may lead to a

double-dip recession.

n However, federal, public and privatedebt is at historic levels we are

borrowing more than is prudent.n So, should we increase taxes and

reduce spending in a weak economy?



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Automatic Spending Cuts

n Directed reductions that begin onJanuary 2, 2013, of $1.2 trillion over 10years.

n Federal spending cuts:n Defense $55bn in 2013 (a 10% cut to every program.)

n Other - $55bn (an 8% average to every program.)



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Bush-Era Tax Cuts Expire

n Income Tax Rates Risen Will be: 15%, 28%, 31%, 36% and 39.6%,n Up from 10%, 15%, 25%, 28%, 33% and 35%.

n Capital-Gains Rate Risesn Increase from 15% to 20%

n Dividend Tax Rate n Increase from 15% to ordinary income rate

n Other tax credits reduced or eliminated



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Others

n Payroll taxes back up to 6.2% from 4.2%(This funds Social Security system).

n Unemployment-benefits extension expires.n Medicare-payment rates to physicians drop by

27%. (Congress has repealed thisrequirement every year since it was passed.)

n New Medicare surtax of 3.8% on individualswith AGI above $200,000, on all income.



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Potential Calendar-Year Fiscal

Impact, 2013 (in $bn)*

n Discretionary-spending caps $ 84 Most Impactn Health-care law taxes 21 .n Payroll-tax cut expires 116 .n Bush tax cuts for wealthy expire 45 .n Bush tax cuts for others expire 150 Impactn Tax extenders expire 30 .n Extended jobless benefits expire 25 .n Physician payment cut 20 .n Alt. min. tax not patched 94 Least Impact

Total $670

Strictly Financials 13(The Economist, Nov 10-14, 2012)


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MAKING SENSE OF THE TAX

ISSUES

Congress also will be considering a major

tax overhaul. Here are some taxexpenditures that have been mentionedfor reduction or elimination.



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Tax Breaks Under Fire and

Their 2012 Costs1

n Health Care employer-provided insuranceand Medicare: $201B

n Savings Incentives 401Ks, IRAs, defined-benefit plans: $135B

n Mortgage-Interest Deduction $ 84Bn

Dividends and Capital Gains $ 93Bn Charitable Donations $ 40Bn State-Tax Deductions $ 47B


1Laura Saunders, WSJ, Weekend Edition, Nov 8-9, 2012


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Tips for Following this Story

n Be careful of your emotions versus thefacts of the stories.

n People usually form their opinion abouttax policy based on their personal

situation Dont tax me and dont tax

thee; tax the one behind the tree!n Educate readers about the public policy

implications of tax policy.



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Story Ideas:

n Does your community have Departmentof Defense installations?

n Is your state a net giver or takerregarding federal taxes and payments?

n Do you live in a high-tax or low-taxstate? Changes in tax laws will impactcommunities differently.



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WILL SOCIAL SECURITY ANDMEDICARE BE YOUR SECURITY?


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Social Security and Medicare:

The Looming Political Crisisn Social Security (taxes paid on income up to

$113,700 in 2013).n Provides retirement benefits for a worker and his/her spouse

to the second death

n Provides disability benefits to injured workers regardless ofage

n Provides survivor benefits to widows and eligible children toage 19 (or 22).

n Medicare (tax paid on total income)n Provides hospital insurance at age 65 and aboven Dont forget to register before you turn 65!


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FAQs Regarding the SSA

n How much can I earn and still receivebenefits?n After reaching full retirement age (FRA), your SS benefits

will not be reduced, but

n If your income is over $44,000 (joint), 85% of benefits willbe taxable.

nAt what age should I start taking Soc Secbenefits 62 years, 66 years, 70 years?n Also, keep in mind that SSA and Medicare are independent

decisions. You have to sign up for Medicare at 65, but youdont have to start drawing SS benefits.


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Social Security Myth 1

nTheres a lockbox that keeps and invests theFICA taxes you pay. No, not reallyn Taxes paid by current workers are used to pay the benefits

of current retirees. You dont have an individual accountwith your money in it, just a ledger balance at the SSA.

n Surpluses are deposited in the Social Security Trust Fund,which then buys non-marketable U.S. government bonds.In reality, this goes directly to fund the federal deficit.


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Current Status of Social Security

Trust Fund (from the 2011 Social Security Trustees Report)

n In 2010, Social Security costs exceededincome from payroll taxes for the first time.n

Recession reduced payrolls.n Baby boomers started to retire. (We already know this

theyve been around for 65 years.)

nAfter 2012-14, costs will exceed income, sointerest payments from trust fund will be

needed to fund payments.

nAfter 2022, taxes and interest will beinsufficient so the trust fund corpus will haveto be used to fund benefits.



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What About the Trust Fund?

n In 2036, the trust fund will be exhausted.n But, yearly payroll taxes could still pay about 75% of current

benefits.

n Assuming no new legislation, the replacementrate (Social Security benefits/pre-retirementearnings) would drop from 41% today to 36% in2036 to 29% in 2037.

n If payroll taxes immediately were raised by 1.92%,(i.e.. .96% each for worker and employer), the 41%benefit level could be maintained to 2086.



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Social Security Myth 2

nI dont count on Social Security because itwill be broke when I retire. Not True.

n This is a legal obligation of the U.S. government,which it really cannot choose not to pay.n Do you really think the government can renege on

its promise to pay your benefits that you havealready paid for?

n What if your employer decided it was not going topay your retirement benefits that you had beenpromised?

n A politically explosive issue


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What Should Congress Do?

n Increase SS retirement age?n Originally set at 65 in 1935, but life expectancy has

dramatically increased.

n Increase income tax on SS benefits?n Currently, if your taxable income exceeds $44,000 (joint),

85% of SS benefits become taxable.

n Uncap the wage level for payroll taxes (set at$113,700 for 2013)?n Medicare taxes currently are uncapped

n Increase the payroll tax?n By 1.96% total as shown earlier


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What About Medicare And

New Health-Care Legislation?

n The real economic issue is spending on healthcare.

n Future Social Security benefits/costs can bemathematically determined, so it becomes apolitical problem to solve; medical costscannot be estimated with any accuracy.

n The real cost and impact of the AffordableCare Act is a great uncertainty.


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Figure 2. Components of Mandatory SpendingAs a Percentage of Federal Spending (FY1970-FY2022)

0%

10%

20%

30%

40%

50%

60%

70%

80%

1970

1972

1974

1976

1978

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

2004

2006

2008

2010

2012

2014

2016

2018

2020

2022

Fiscal Year

PercentageofTotalOutlays

Social Security

Medicare

Medicaid

Income Security

Other Retirement and Disability

Other Mandatory

Other Health Programs

Source: Offsetting receipts are excluded. CRS calculations based on data from CBO, Historical Tables and BudgetProjections. CBO baseline projections depicted to the right of the vertical line.

Source: Congressional Research Service, March 12, 2012


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Information about Social

Security and Medicare

n Center for Retirement Research atBoston College. http://crr.bc.edu/

n List of publications at:http://crr.bc.edu/social_security/social

%2520security%3bbriefs.html


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Story Ideas

1. Do your readers believe that Social Security will paythem retirement benefits?

2. Do they favor changes to the system that will ensureits survival (1) increase retirement age, (2)increase taxes, (3) increase taxable wage base?

3. How does Social Security fit in your retirementplanning?



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WILL THE COMING CRISISIN PUBLIC PENSION PLANS

AFFECT YOUR COMMUNITY?



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Grabbing Headlines

n Series by Craig Harris in the Arizona Republic,2011,Pension Funds in Arizona Facing Bleak Future.

n U.S. Public Pension Plans are Different (and Not in aGood Way! Jeffrey Brown, Forbes, June 11, 2012.)

n New Rules may make Public Pensions AppearWeaker,Reuters.com;June 25, 2012.

n An officer earning $150,000/year will retire earning$140,000/year for the rest of his/her life, for a totalbenefit of $5.9 million (to age 85).



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Two Principal Types Of

Pension Plans



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Defined-Benefit Plans

n Employer assumes obligation to pay retirementbenefits defined by formula.

n Retirement benefits determined by acalculation:

n e.g. = (years of service*2%*avg. 3 yrs. of highestsalary)

n Most public pension plans are of this type.n Market risk is carried by the state sponsor, and the

investments are professionally managed.

n No asset available to transfer to heirs.n $4,357 billion of assets in DB plans (as of Sept. 30, 2009)



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Defined-Contribution Plan

n Employer assumes only obligation to pay yearly % ofsalary (e.g., 10%) into employee-selected investment

vehicle (think 401-k).n Individual bears the market risk and is responsible for

selecting investment vehicles.

n Retirement benefits determined by performance ofinvestment choices.

n Most newer corporate plans are of this type.n Value of assets becomes part of estate that can be

transferred to heirs

n $1,720 billion of assets in DC plans (as of Sept. 30, 2009)Strictly Financials 35


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Ten Largest Defined-Benefit

Funds*


$0 $50 $100 $150 $200 $250

Calif. Public Emp.

Calif. State TeachersNY State Common

Fla. State Board

NY City Retirement

Texas Teachers

Gen. Motors

NY State TeachersWisc. Investment Brd.

State of New Jersey

Total Assets in Billions of $

*as of Sept. 30, 2009,* from Pensions & Investments, Dec. 28 and Feb. 8, 2010)


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Typical Pension-Plan Sponsors

n State or municipal employee plans (almost allare defined-benefitplans):n Teachers (K-12, community colleges, universities)n State employeesn Firefighters and policen Judges

n Local union plans (usually defined-benefitplans)

n Corporate plans (most have converted todefined-contributionplans)



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Measuring Pension-Plan Health

n Actuaries can project future plan liabilities andincome key factors are:

nWorkforce demographics

n Rate-of-return assumptionsn Mortality rates and we are living longern Size of investment portfolion COLAs cost of living allowances (e.g., 2% a year)

n The present value of projected pension paymentsand income to the plan is used to calculate the

funding ratio: $ projected payments/$ income

n A funding ratio of at least 80% is considered safe.



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GASB Changes May Make Public

Plans Look Weaker

n Major changes to be phased in starting June2013:

n Plan sponsor (e.g., state or school district) mustshow pension liability on balance sheet (previouslyshown as a footnote to financial statements).

n Poorly funded plans will have to lower discountrate (to a municipal-bond rate) on liabilities (which

makes funding ratio worse.)

n Teacher retirement plans are especially vulnerableto show a weaker financial position.



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But Be Skeptical About Studies

Which Predict Plan Insolvency

n Most studies use historical aggregate data, whichmay not include recent plan improvements.

n Projections are based on many assumptions. For bestinformation, use the yearly actuarial report, which allpublic plans require.

n Dont confuse accounting books with actualinvestment performance.

n In addition to the current funding ratio, considerthe

n Funding horizon and its trend over the past decade.n The trend in the funding ratio over the past decade.



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States are Acting to Changetheir Public-Pension Plans

Yes, there is a problem that should beaddressed sooner rather than later.



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The Economist, June 23, 2012


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Unfortunately, the FundingGap Continues to Widen

The Funding Gap is an actuariallydetermined value calculated asthe ratio of the present value ofpromised benefits/present valueof assets.



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What Can Be Done to Shore Up

Public Pensions?

n Changing payouts for current employees islegally difficult to impossible, so states look to

make changes for new employees.n Bankruptcies by local governments have been

one option. (States cannot use bankruptcy.)

n Typical choices for improving funding:n Raise retirement eligibility/agen Increase state/employee contributionsn Replace defined-benefit with defined-contribution

plan a costly action for most plans.



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What the Future Holds

n In 2008, most plans were funded at over 80%, butby 2011, only 35% were.

n Falling stock market reduced portfolio valuesn Reduced contributions from states as they struggled to

balance budgets.

n Alternatives for state and local government plansn CA, IL, NJ may need to increase contributions to 8-12% of

state budgets to keep plans solvent.

n Most states need to increase contributions an additional 2%of state budget to get funding up to 80%.

n Experiences of Minnesota and Colorado to change planbenefits.



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Story Ideas

1. What is the financial health of pension plans in yourarea? (Public plans have to provide data.)

2. Are plan administrators considering actions to modifyplans? What resistance is expected?

3. What has been the financial performance of the fundover time? Is it competitive with other plans?

4. What is retirement pay for high-paid employees?Strictly Financials 48


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Resources

nCovering your local pension plann SABEW Teletraining, Dec. 5, 2011n Detailed tutorial by David MilsteadnArchived webinar with Barlett and Steele

winner Craig Harris of The Arizona Republic

nArchived resources at NewsU fromSABEWs 2011 public pensions seminar

n Overview from the National Council ofState Legislatures



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What about the EuroAnd the European Union?



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The European Union

n Created by the Maastricht Treaty in 1991n Introduced the Euro () in 1999 at a value of

$1.18 per 1.n 16 countries now use the

n Austria, Belgium, Cyprus, France, Finland,Germany, Greece, Ireland, Italy, Kosovo,

Luxemburg, Malta, Netherlands, Portugal,Slovenia, Spain.

n Denmark, Norway, Sweden and the U.K. do notuse the but are part of the European Union.



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Why have a Monetary Union?

nAdvantages:n Reduces costs (dramatically)n Eliminates exchange rate uncertaintyn Promotes trade and political cooperation

n Disadvantages:n Loss of monetary independence and controln Tensions between rich and poor statesn Difficulties in maintaining unified control



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Key Criteria for Membership

n Ratio of Budgetary Deficit to GDP 3%n U.S. is 10.64% in 2011 budgetn

EU is 6.3% in 2010n Ratio of Gross Public Debt to GDP 60%

n U.S. is 94.27% in 2010n EU is 74.0% in 2010

nBut, most members violate these measuresand have done so through time.



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So, Whats the Problem?

n Sovereign default is possible.n Greece, Ireland, Portugal and Spain may be

unable to repay or refund debt as it comes due.n But, because most of the debt is held by

European banks, the EU set up a bailoutfund.

n What impact will the fear of a debt crisis inEurope have on the international bankingsystem and interest rates?



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Story Possibilities

1. What impact would death of the Euro have on businessesin your city?

2. What relationship do banks in your area have with globalbanks?

3. Do banks/pension funds/investors in your city or statehold foreign bonds?

4. Do companies in your area do business with Greece,Portugal, Ireland or Spain?


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