Money, banking & insurance

The pensions crisis

It seems as if America is lurching from one kind of financial crisis to another, and the latest is public pensions. Workers are living so much longer than they used to, and the burden of paying pensions is swelling every year. Not only that, the cost of paying them keeps being deferred so that later generations are faced with a growing debt. As Roger Lowenstein writes, states should require that every dollar of pension benefits be funded as the benefit is accrued, wiping away the illusion that pensions are “free”.

His book, While America Aged, charts the story of the New York Metropolitan Transit Authority’s fight with the union over pensions. From 2000-2005, its pension bill for the subway and bus system rose ten times. Employees paid only 2% of their salaries for pensions and nothing for health care. Obviously this was not tenable, but a public agency can never “stop the meter” and governments cannot become bankrupt to escape paying pensions.

America is not the only country facing a mounting pensions bill. All countries with aging populations are looking at how they will support retirees, as well as other people who rely on social security. Few people do save the kind of money they need to live on. The American experience of workers under-funding their own pensions is very similar to the credit crisis because it relies so much on paying later, and because it takes responsibility for the future out of their hands. It’s a shift in mindset. The idea that money was ever free, or grew on credit cards (See The Credit Card Wild Card - issue 22), was a destructive illusion.

The credit card wild card

Mortgages were one problem, but the $US700 billion bailout for banks won’t help issuers of credit cards. Outstanding credit card debt has topped $US950 billion and, like weeds, will just keep on growing as 37% of lenders push up interest rates. The usual process is for banks to sell about 70% of consumers’ outstanding balances to hedge or pension funds. But buyers are thinner on the ground now, forcing banks to put up more money as collateral.

Credit card debt is unsecured, which means consumers don’t make a down payment when they open an account. If they stop paying off their debt, there are no underlying assets, like a house, to claim. This has led to some questionable practices among lenders, such as charging a fine when payments are only one or two days’ late, or jacking up interest rates to “bad” payers. The US House of Representatives voted 357-70 in early May for legislation to curb arbitrary interest rate increases and ensure cardholders who pay on time are not penalised.

Banks were heavy handed in their quest to up-sell credit cards and credit card limits and the results of that are clear now. Consumers, in turn, were light headed when faced with such easy access to credit. Even though legislators have stepped in, banks have a PR opportunity to change their attitudes to offering credit, and customers might want to reassess their need to buy on credit. It sounds rather like the French reassessment of values (See The French embrace “new modesty” - issue 22) but, ironically, they prefer not to use credit cards.

 

The new frugality

There is no doubt that frugality is in, whether it manifests as buying fewer luxuries, shopping in discount stores, or renting dogs (see story, You Can Rent Almost Anything - issue 22). Some 55% of Americans have cut household spending, according to Gallup, and they have cut holiday spending, eating out, going to the movies, and household services.

Whatever they earn, cutting back on dining out is the number one or two choice for Americans, according to WSJ Retail. They are also more likely to use coupons when they do their grocery shopping. As part of the “new modesty”, 20% say they are saving to buy something they want rather than buying it now on credit. Half of shoppers surveyed by Unity Marketing claim they will be spending less on luxury items.

After September 11, more Americans stayed at home, and a similar trend is emerging here. They are travelling less for leisure, and choosing to rent movies rather than go out to the cinema. The downside of these cutbacks is that all the people who work in these industries will feel the pain in their pockets. But there seems to be a change in psychology, almost an aversion to consumption. As one consultant remarks, “People aren’t shopping to feel better. They actually are not shopping to feel better.”

EBay says Americans could have $US3,200 worth of goods at home they could sell for cash. (and it may help to declutter). It has become mainstream to take on some of the thrifty behaviours of the greenies, such as shopping in second-hand stores or cooking local produce at home. It will be interesting to see whether consciousness of the environment becomes a secondary concern, even though it is served by thriftier behaviour.

 

Look after your own kind, but not too much

As often happens in a crisis, people turn to their own communities and protect each other. This may not work so well when communities, indeed countries, are intricately connected with others in a global economy. America’s stimulus package, which demanded use of American materials in public works, took a backlash from Europe as unwelcome protectionism. But similar demands have come from that side of the globe: “British jobs for British workers” and one million French workers, who staged a strike on January 29 for jobs and wages.

One scapegoat in a downturn is trade, and only 53% of Americans think trade is good for their country. This might just be ignorance: in 2007, exports rose by $US190 billion, in 2008, by about $US300 billion, in spite of the crisis in consumer spending. Trade has been crucial in reducing the pain of the economic downturn. At least that is the view of the economists.

Nationalism becomes most vocal in banking and it is easy to see why if you’re an economist: banks have relationships with millions of households and businesses and they help put savings into productive and profitable places. No-one wants their local banks to collapse. However, nationalising them is not the answer, particularly with so many unwanted banks around, and the temptation, described by The Economist, to “change them into instruments of policy”.

Try telling any of this to someone who has just lost their job, and if they see that job go overseas where labour is cheaper. Tell this to someone who has just seen her pension or superannuation nest egg fall by 20%. However much the leaders in America champion the cause of free markets, it is going to be hard to convince ordinary people who are not economists. This is why there is a return to nationalism and protectionism and – like the wars that also engendered it – it won’t last.

Peer-to-peer loans

First we had peer-to-peer software creation, like Linux, then downloading of songs, via Napster. Now it looks as if peer-to-peer lending is taking off. With credit so tight, people are starting to borrow from each other. Whenever people come together with a pool of capital, it is possible for them to create more wealth than they might alone. One example is Lending Club, which offers a lending rate of 7.88% to its best customers, compared to more than 13% for a personal loan from a bank. It is likely that, as peer-to-peer lending becomes more common, banks will start to include this method in their lending products. This might well be one of the most exciting developments in banking especially as it returns us to the way things used to be, before banks.

BTW, how about a physical bank setting up a P2P lending operation whereby the bank's richest customers could lend money to the bank's poorest customers?