Why Low Interest Rates Mean Big Bills

Why Low Interest Rates Mean Big Bills

Some of the inevitable bills for lawmakers' refusal to pay for their spending will show up much sooner than expected.

There’s a dark side of the U.S. Federal Reserve’s continuing low interest-rate policy, as Janus Capital’s respected lead portfolio manager, Bill Gross, explains in his latest Investment Outlook newsletter. The longer it remains difficult for state and city employee pension funds to earn a decent return on their investments, he writes, the sooner taxpayers will be forced to cover shortfalls to make good on retirement benefits politicians promised to public workers.

Hints of this problem have been visible for some time in the financial struggles of Detroit and Puerto Rico, but with Chicago we now have the proverbial canary in the coal mine. Mayor Rahm Emanuel recently announced the largest tax increase in the city’s history: $712 million annually to supposedly save worker pensions. It includes a $588 million hike in property levies, a $9.50 per month garbage collection fee, and $48 million in surcharges on taxicabs and ride-sharing services such as Uber.

Of course, the Fed’s near-zero interest rate policy, technically known as “quantitative easing,” is not the sole reason for the Windy City’s crisis. Chicago public officials have aggravated the problem for years by cutting required pension contributions to give the illusion of balanced budgets.

But this political gimmick only explains why Chicago has become the first city or state government to present its citizens a dramatically higher tax bill to replenish retirement reserves. Taxpayers nationwide are about to face the same problem. “The bottom line,” says Wharton finance professor Robert Inman, is that the nation’s major cities have a collective $400 billion unfunded liability, while states share a staggering $3 trillion pension deficit. “That turns out to be about $10,000 per American citizen” just to date, he says.

Cooking Our Wallets Alive On a Spit

The critical threat low interest rates pose to government employee pensions was actually foreseen three years ago by the Government Accounting Standards Board, the most widely recognized authority on public finance. In reaction, it adopted two accounting rules to prevent pension trustees from continuing to assume high rates of return as they had before the Fed began quantitative easing. It hoped aroused taxpayers would recognize their growing liability for inadequate retirement reserves and create political pressure for change.

Aggregate funding for all state pension plans is still falling, last year from 73.1 percent to 72.6 percent.

But a recent report shows the problem persists. Municipal bond firm Loop Capital found that aggregate funding for all state pension plans is still falling, last year from 73.1 percent to 72.6 percent. Four states—Alaska, Illinois, Kentucky, and Connecticut—are only 50 percent funded, while New Jersey is down to 39 percent.

With pension funds in Boston, Houston, New York, and Philadelphia in just marginally better shape than Chicago’s, Gross has observed that American taxpayers “are not so much in a pickle barrel as they are on a revolving spit, being slowly cooked alive [by the Fed’s] central bankers.”

Immediate Benefits, Long-Term Disadvantages

For the six years the Federal Reserve has been sitting on interest rates, political observers have tried to assess the net impact on voters. On the plus side, auto loans are cheaper, and homeowners have been able to refinance their mortgages at lower rates. Stocks in Individual Retirement Accounts have also appeared to benefit, at least until recently.

Low rates have also made it possible for Washington to double the national debt from $9 to $18 trillion.

But the negatives, while less immediately obvious, are no less real. Near-zero interest rates have made it more financially attractive for companies to buy back their own stock than to invest in plants and equipment, which leads to stagnant wages and fewer opportunities for people to get promoted to higher-paying jobs.

Low rates have also made it possible for Washington to double the national debt from $9 to $18 trillion during President Obama’s tenure without exploding the federal budget line for annual interest on borrowing.

Given the choice of treating consumers to the immediate benefits of low interest rates or doing what is necessary for everyone’s long-term economic health, it should be no surprise that Washington policymakers have postponed being fiscally responsible as long as they could. But what cities like Chicago are now telling us is that some of the inevitable bills for this hesitation will show up much sooner than expected.

The tab will not sit well with taxpayers.

Lewis Andrews is the editor of www.SmartTowns.org and author of "To Thine Own Self Be True: the Relationship between Spiritual Values and Emotional Health" (Doubleday).
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