November 11, 2010
Market Risk v. Political Risk
Posted by Jeff Schwartz

In my last post, I suggested that government insurance of market returns was a theoretically attractive way to provide a more equitable vehicle for retirement savers.  I have concerns, however, about how it would work in practice.

It seems that to move in this direction would be to swap market risk for political risk.  Rather than face market volatility alone, individuals would face the risk that government would renege on its guarantee obligations if it felt such action was necessary.  This strikes me as a real possibility.  Who knows what market returns will be in the future.  If they are not as forecasted, our government would find itself in a bind, and a politically attractive way out might be to alter pension obligations.  This concern seems particularly trenchant in light of our treatment of social security.

The central problem appears to be that a return guarantee imposes a long-term static obligation in connection with something that is dynamic, namely market returns.  As the divergence between expectations and reality inevitably builds, political and economic concerns may take precedence over earlier commitments.

Perhaps a guarantee could be designed so that it is flexible over time.  But too much flexibility and the guarantee becomes meaningless.  This strikes me as a difficult balance to strike. 

The design problems and political risk associated with government guarantees leave me to wonder whether reforms should focus on improving, rather than abandoning, the current paradigm, where government makes no promises.  It seems to fall far short of egalitarian ideals, but perhaps it is the best among imperfect alternatives.

Finance, Investing, Securities | Bookmark

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