4 ms·

Could you explain this a bit more, or link to something that does? I'm don't know much about the Fed or the effect of bond interest rates. In particular: 1. Th

by deogeo 7y ago

Could you explain this a bit more, or link to something that does? I'm don't know much about the Fed or the effect of bond interest rates. In particular: 1. The idea that interest rates should be high to prevent other, riskier investments, reads rather like we have to bribe investors into not gambling too much. 2. How do low interest rates 'refill the punch bowl', as you said? 3. How do they incentivize separating people from their money? The interest on those bonds is ultimately paid out of taxes, no? So wouldn't high interest rates be separating people from their money, making things better now at the cost of having to repay more later? 4. The bonds the government issues basically act as a loan the govt. takes from whoever buys the bonds, no? So shouldn't the interest rate be set as low as possible while there are still willing buyers? Honestly none of this makes sense, and I'm pretty sure I'm missing something major.

thorwasdfasdf 7y ago
When interest rates go down, it means safer investments become less attractive. For example, lets say you have 1 million dollars in the bank account. if the bank pays you 0% then you're not very likely to keep your money there. You're much more likely to put it in the stock market, a hedge fund, a high yield muni bond or anywhere else. What all those "anywhere else" have in common, is that they're all higher risk. So, collectively by reducing interest rates you are incentivizing risky behavior. And it's not just individual players. Think about all those pension funds and insurance company funds that need to make returns to fund people's retirements. Collectively they have trillions of dollars on the line, and no choice but to invest in increasingly risky funds. Once you understand the connection between low interest rates and risk, as a follow up, watch this: https://www.youtube.com/watch?v=k9_bWbrYPKg https://www.youtube.com/watch?v=k9_bWbrYPKg Brian Reynolds has a ton of experience working in the pension industry and this is an extremely fascinating interview (though a bit advanced, but you can still understand some of it)
- deogeo 7y ago
  So literally pay investors so they can get richer without risk? "A legal mandate requires these funds to generate 7.5% returns, and when they fail to do so, taxpayers foot the bill." - it sounds like it would be much cheaper for taxpayers to pay pension funds directly, instead of paying all investors, and hoping some of that money finds its way to pensions. Actually, let me get back to "by reducing interest rates you are incentivizing risky behavior". Phrased this way, it sounds obvious that 'of course you should try to reduce risky behavior'. But risky behavior of what? Is a car manufacturer going to take more risks because of low interest rates? No - they make a profit from selling cars. Same for farming, mining, pharma, advertising... literally every industry, except the purely financial ones. So... are we just paying tax money to bankers, and getting nothing in return? Because they convinced us that if their profits were any lower, they'd start taking so many risks banking would collapse (instead of more prudent banks emerging)?
  - thorwasdfasdf 7y ago
    > So literally pay investors so they can get richer without risk? No. it's exactly the opposite. When government steps in and offers 0% interest rates, it's subsidizing the money lending by handing out cash like it's free candy. It's preventing the natural lending that would have occurred if it didn't step in. Hence offering 0% interest uses the power of government to force people into riskier assets.
    - deogeo 7y ago
      How are 0% interest rates 'handing out cash'? I thought bonds worked in the following way: Buy bond at N% interest. When it matures, government pays you original price + N%. So 0% would be bond buyers handing cash to the government, no?
      - whatshisface 7y ago
        Fed interbank interest rates aren't the same thing as treasury bond interest rates. Yes, when money is cheap bonds become almost worthless, that can be seen in the market right now. However the cash party isn't for people buying bonds, it's for people with access to the inside track of low-interest money.
        deogeo 7y ago
        So when talking about 'fed interest rates', what is meant is https://en.wikipedia.org/wiki/Federal_funds_rate https://en.wikipedia.org/wiki/Federal_funds_rate ?
        whatshisface 7y ago
        Yes, that's the interest rate that impacts the money supply (along with other factors) by greasing bank's balance sheets. Treasury interest rates are set by the market, they are whatever they have to be to get people to buy government debt.
      - 7y ago
- nradov 7y ago
  This is exactly why defined benefit pension plans need to be eliminated. They're just too risky for everyone concerned and create a huge moral hazard. Defined contribution plans like 401(k) with named individual accounts are much safer.
  - wahern 7y ago
    They're only a moral hazard if the plan is permitted to make promises without requiring the promisee to deposit enough funds. And that can only happen for government employee pension plans; private employee pension plans are required by Federal law to follow strict accounting rules which keep the pension fully funded--at any point in time the future expected liabilities must be backed by deposited funds sufficient to cover the liabilities according to a moderately conservative rate of return (e.g. 5-6%). Private pension plans can and have failed, but that's because corporations sometimes devise clever ways to drain funds. They usually have to do this quickly, though, so it often occurs during mergers and acquisitions where the CFO can shift funds and pay them out as dividends, stock buybacks, or bonuses. Then when the Feds come knocking on the door six months later the CFO moans and cries to the regulators and shareholders[1] about how their pension liabilities are a crippling burden, which is total B.S. because if they hadn't played games the pensions should represent a $0 liability at any point in time. Actually, because of the way the market works--long runs of above average returns followed by sharp below average returns--CFOs just as often claim that their pension funds represent idle money. Of course it's not idle, it's invested in the market, and while those funds are nominally controlled by the employer in reality they're an expenditure no different than the paycheck the cut their employees every other week. Public pensions, however, aren't required to be fully funded. Politicians are happy to promise huge pensions to placate employee unions without giving a second thought to how they might actually fund those future liabilities today. (Notably, unlike state-government employee pension plans, Federal employee pension plans are kept fully funded as required by separate Federal law, notwithstanding the USPS, which has a complex, unique story of its own.) A defined-benefit pension is basically just an annuity, and any economist will tell you that annuities are one of the most rational and efficient retirement devices around. The real retirement crisis that we'll see (and which we got a glimpse of during 2008-2010) is when people realize how risky and poorly funded their 401(k) plans are, especially during economic downturns. It's going to be epic particularly because most people only invest 4-5% of their wages into a 401(k) at best, whereas for somewhat historic reasons defined-benefit pension contributions usually represent 20-30% of compensation. Things are going to get nasty.... What we should be doing is incentivizing pension plans, not disincentivizing them. Pension plans should be the dominate retirement strategy. But because the potential for moral hazard is significant when governments make these promises (there's no higher authority to ensure promises are backed by commensurate present funding), we can't rely on government to do this directly. Social Security is very similar to a defined-benefit plan in the sense that there's a set formula for benefits based on wages, and it's a very important safety net we should strive to maintain. But it's just a safety net and we shouldn't expect anything more of it. A great book explaining the history of pensions and the shift to 401(k)s is "Retirement Heist: How Companies Plunder and Profit from the Nest Eggs of American Workers", https://www.amazon.com/Retirement-Heist-Companies-Plunder-American/dp/1591845653 https://www.amazon.com/Retirement-Heist-Companies-Plunder-Am.... The author was an investigative journalist for the Wall Street Journal, and the book explains in interesting and somewhat technical detail the legal and financial machinations of defined-benefit (pension) and defined-contribution (401(k)) plans. [1] Investors who conveniently forgot or had no interest in understanding where that windfall they received 6 months earlier came from.

by deogeo 7y ago

thorwasdfasdf 7y ago

When interest rates go down, it means safer investments become less attractive. For example, lets say you have 1 million dollars in the bank account. if the bank pays you 0% then you're not very likely to keep your money there. You're much more likely to put it in the stock market, a hedge fund, a high yield muni bond or anywhere else. What all those "anywhere else" have in common, is that they're all higher risk. So, collectively by reducing interest rates you are incentivizing risky behavior. And it's not just individual players. Think about all those pension funds and insurance company funds that need to make returns to fund people's retirements. Collectively they have trillions of dollars on the line, and no choice but to invest in increasingly risky funds. Once you understand the connection between low interest rates and risk, as a follow up, watch this: https://www.youtube.com/watch?v=k9_bWbrYPKg https://www.youtube.com/watch?v=k9_bWbrYPKg Brian Reynolds has a ton of experience working in the pension industry and this is an extremely fascinating interview (though a bit advanced, but you can still understand some of it)

deogeo 7y ago
So literally pay investors so they can get richer without risk? "A legal mandate requires these funds to generate 7.5% returns, and when they fail to do so, taxpayers foot the bill." - it sounds like it would be much cheaper for taxpayers to pay pension funds directly, instead of paying all investors, and hoping some of that money finds its way to pensions. Actually, let me get back to "by reducing interest rates you are incentivizing risky behavior". Phrased this way, it sounds obvious that 'of course you should try to reduce risky behavior'. But risky behavior of what? Is a car manufacturer going to take more risks because of low interest rates? No - they make a profit from selling cars. Same for farming, mining, pharma, advertising... literally every industry, except the purely financial ones. So... are we just paying tax money to bankers, and getting nothing in return? Because they convinced us that if their profits were any lower, they'd start taking so many risks banking would collapse (instead of more prudent banks emerging)?
- thorwasdfasdf 7y ago
  > So literally pay investors so they can get richer without risk? No. it's exactly the opposite. When government steps in and offers 0% interest rates, it's subsidizing the money lending by handing out cash like it's free candy. It's preventing the natural lending that would have occurred if it didn't step in. Hence offering 0% interest uses the power of government to force people into riskier assets.
  - deogeo 7y ago
    How are 0% interest rates 'handing out cash'? I thought bonds worked in the following way: Buy bond at N% interest. When it matures, government pays you original price + N%. So 0% would be bond buyers handing cash to the government, no?
    - whatshisface 7y ago
      Fed interbank interest rates aren't the same thing as treasury bond interest rates. Yes, when money is cheap bonds become almost worthless, that can be seen in the market right now. However the cash party isn't for people buying bonds, it's for people with access to the inside track of low-interest money.
      - deogeo 7y ago
        So when talking about 'fed interest rates', what is meant is https://en.wikipedia.org/wiki/Federal_funds_rate https://en.wikipedia.org/wiki/Federal_funds_rate ?
        whatshisface 7y ago
        Yes, that's the interest rate that impacts the money supply (along with other factors) by greasing bank's balance sheets. Treasury interest rates are set by the market, they are whatever they have to be to get people to buy government debt.
    - 7y ago
nradov 7y ago
This is exactly why defined benefit pension plans need to be eliminated. They're just too risky for everyone concerned and create a huge moral hazard. Defined contribution plans like 401(k) with named individual accounts are much safer.
- wahern 7y ago
  They're only a moral hazard if the plan is permitted to make promises without requiring the promisee to deposit enough funds. And that can only happen for government employee pension plans; private employee pension plans are required by Federal law to follow strict accounting rules which keep the pension fully funded--at any point in time the future expected liabilities must be backed by deposited funds sufficient to cover the liabilities according to a moderately conservative rate of return (e.g. 5-6%). Private pension plans can and have failed, but that's because corporations sometimes devise clever ways to drain funds. They usually have to do this quickly, though, so it often occurs during mergers and acquisitions where the CFO can shift funds and pay them out as dividends, stock buybacks, or bonuses. Then when the Feds come knocking on the door six months later the CFO moans and cries to the regulators and shareholders[1] about how their pension liabilities are a crippling burden, which is total B.S. because if they hadn't played games the pensions should represent a $0 liability at any point in time. Actually, because of the way the market works--long runs of above average returns followed by sharp below average returns--CFOs just as often claim that their pension funds represent idle money. Of course it's not idle, it's invested in the market, and while those funds are nominally controlled by the employer in reality they're an expenditure no different than the paycheck the cut their employees every other week. Public pensions, however, aren't required to be fully funded. Politicians are happy to promise huge pensions to placate employee unions without giving a second thought to how they might actually fund those future liabilities today. (Notably, unlike state-government employee pension plans, Federal employee pension plans are kept fully funded as required by separate Federal law, notwithstanding the USPS, which has a complex, unique story of its own.) A defined-benefit pension is basically just an annuity, and any economist will tell you that annuities are one of the most rational and efficient retirement devices around. The real retirement crisis that we'll see (and which we got a glimpse of during 2008-2010) is when people realize how risky and poorly funded their 401(k) plans are, especially during economic downturns. It's going to be epic particularly because most people only invest 4-5% of their wages into a 401(k) at best, whereas for somewhat historic reasons defined-benefit pension contributions usually represent 20-30% of compensation. Things are going to get nasty.... What we should be doing is incentivizing pension plans, not disincentivizing them. Pension plans should be the dominate retirement strategy. But because the potential for moral hazard is significant when governments make these promises (there's no higher authority to ensure promises are backed by commensurate present funding), we can't rely on government to do this directly. Social Security is very similar to a defined-benefit plan in the sense that there's a set formula for benefits based on wages, and it's a very important safety net we should strive to maintain. But it's just a safety net and we shouldn't expect anything more of it. A great book explaining the history of pensions and the shift to 401(k)s is "Retirement Heist: How Companies Plunder and Profit from the Nest Eggs of American Workers", https://www.amazon.com/Retirement-Heist-Companies-Plunder-American/dp/1591845653 https://www.amazon.com/Retirement-Heist-Companies-Plunder-Am.... The author was an investigative journalist for the Wall Street Journal, and the book explains in interesting and somewhat technical detail the legal and financial machinations of defined-benefit (pension) and defined-contribution (401(k)) plans. [1] Investors who conveniently forgot or had no interest in understanding where that windfall they received 6 months earlier came from.