TCS Daily

Boomer Bust

By Robert M. Bryce - February 4, 2009 12:00 AM

In 2008 the housing bubble burst and wrecked havoc on the world economy. The realization that there was a problem brewing was delayed, and by the time it was clear, too late. Various cures are being hastily proposed and enacted, without clear evidence of plausible success, reasoned discussion, or trade-off considerations. In the absence of quality quantity is the order of the day, and huge stimulus packages are being floated.

I thought the bursting of the 2008 housing bubble would be delayed until a sizable fraction of boomers hit retirement age in the teens of this century, caused by the implausible retirement strategy of the baby boomers: each and every retiree, together holding the majority of individual owned housing and stocks, would sell their assets at current valuations to fund their retirement. This strategy must fail -- as age constraints force mass selling of assets the market-clearing price must fall; prior valuations will be a poor prediction when this occurs (although our most recent, depressed, valuations are more in line with what can be expected).

In hindsight, the phenomena of early retirement, the "Freedom 55" cohort, may mean that a big enough early wave of retirees has hit. The peak of these early retirees is happening now -- and may be the underlying cause of the timing in the market downturn. The retiree selling pressure, who must turn paper value into cash, is further catalyzed by over investment in housing and by highly leveraged financial instruments. The aging of the boomers is going to lead to increasing numbers of retirees over the next decade or so, this pressure will likely lead to a softer recovery in the housing and stock markets then we would like, or a secondary recession in the near future.

The possibility for a sustained recession exists, and it is disconcerting to see that in response to the bubble burst politicians are using costly stimulus packages under the assumption that short term spending, at high rates, will kick start the economy. Add to this the increasing cost of public health and pensions with a reduced tax payer base: it seems that borrowing in order to spend, under the assumption that things will quickly get and stay "back on track", is a poor plan.

The "reduced tax base", IE: the boomers children, will soon have a severe burden: the cost of the stimulus, the costs of poorly managed social safety nets, and, possibly, the cost of helping older relatives who had saved for retirement, only to find projected wealth evaporate. On top of this they must save for their own dreams and retirement, and deal with population stagnation with an economy and policies based on constant growth (hence the under funding of social safety nets). These problems are not insurmountable, but they are real and there will be a painful adjustment period.

Our politicians are not only in the process of not planning for the shock that retirement will bring to our society, but want to spend our way out of current problems with little evidence that this is prudent. So what should be done? Reducing stimulus package outlays would be a good start. If we do face a sustained recession it is reasonable to wait until it becomes clear where money should be directed before spending. Borrowing now constrains borrowing in the future, and after all, excessive borrowing is causing much of the pain we now face. Does it make sense to now take on public debt without careful consideration?

A further problem is much of predicted risk is minimized by hedging in markets: buying offsetting risks. Currently institutions are invested in (often highly leveraged) hedged funds that have been devalued; their buffer to risk is lower than expected (much like retirees buffer for retirement is lower than expected). Institutions are therefore more fragile than they planned, a problem if they optimized close to the edge of financial sustainability -- they will now be susceptible to shocks. This is a strong incentive for holding back on stimulus packages, we may find important uses for our money soon enough. Acting swiftly to reveal and write off the highest risks is painful, but sometimes pulling off the Band-Aid quickly leads to less overall pain. Finally, refraining from ad hoc regulation will allow people to plan for the future -- investments are made even riskier by unpredictable political action.

The current proposals, rapid and high governmental spending with low interest rates to encourage consumer spending and debt consumption, seem to be the opposite of what should be done, and are preconditioned on the assumption that a rapid and sustained recovery is possible. It appears more likely that institutions are currently fragile due to devalued hedges and investments, the recession will either be sustained or followed closely by a secondary recession due to demographics, and that market decisions are being restrained by lack of knowledge of where risks are. Revealing where the most fragile and risky assets reside, refraining from ad hoc decisions, and saving stimulus spending until a time when we can actually see where spending would be reasonable and important seems to be a better plan than spend, spend, spend.

Robert M Bryce is an immigrant from Saskatchewan, living in Alberta. He is currently working on his Ph.D. thesis investigating fluid flows.

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