Market Risks that Are Creating Societal Risks (w/ Danielle DiMartino-Booth & Chris Cole)
DANIELLE DIMARTINO BOOTH: Speaking of systemic, let's end this-- I could talk to you for hours, by the way. This is just fascinating. But let's wrap this up today with where you conclude this wonderful paper. Richard Fisher and I met years ago when I was still inside the Fed. We had lunch there were riots in the streets of Athens at the time. And I said, I said, Richard, what do you make of this? What can we draw from this? I'd been writing about pensions for 20 years. And he said, Danielle, I fear that we'll have those riots in our streets one day, that the public pensioners and the people who are paying for the public pensioners-- if you're Joe Q with an IRA or 401(k), and you lose most of the value of your equity holdings, and you're told that your property taxes or your income tax, state income taxes are going to have to go up to top off the pension that's just lost as much-- you talk about these things in public forums, and individuals go at each other. Talk about the societal implications of where we are today what you see potentially happening, because you used the word systemic. CHRISTOPHER COLE: So the way that the average institutional entitlement portfolio is structured today- - and this is not an opinion. I'm looking back across history. There is a recency bias. This is constructed for the last 40 years of unprecedented asset price growth. But if you look beyond that 40 years and look at how that portfolio will perform, at a best case, you're looking at a 5% type of return. In a worst case, given where debt levels are and where leverage is, you're looking at something much, much worse. So if we just assume the best case, it makes 5% or 4% over the next 20 years, these entitlement programs. DANIELLE DIMARTINO BOOTH: Which is not enough. CHRISTOPHER COLE: Not enough, because they're targeting 7.25%. That will cause an expansion of the unfunded liabilities in just the state systems alone to about $3 trillion. If we end up getting a lost decade, that could go as high as $10 trillion. That $3 trillion number, that is the cost of four bank bailouts. It is the entire tax revenue of the US government over the next year. That is your base case. These entitlement programs, which right now, based on the 7.25% assumption, will go from 70% funded to under 50% funded, and a third of them will be under 30% funded. And this is not including corporate programs and other personal retirement programs. This issue of asset allocation is an issue of systemic risk. It is an issue of social stability, because we will be at a point where these entitlement programs will go belly-up and face insolvency unless we can think differently about the portfolio construction. I could see a lot of different things happening. I could see a day where the Fed prints money to buy pension obligation bonds. DANIELLE DIMARTINO BOOTH: Chris, if I can tell you something, during the crisis, when I was inside the Fed, it was debated. CHRISTOPHER COLE: Wow. That's amazing. DANIELLE DIMARTINO BOOTH: The idea-- if you tech logic to the end game, the idea of the Fed buying municipal bonds is perfectly feasible. CHRISTOPHER COLE: That's right. And that will be a backdoor bailout of Wall Street if that happens. You could see a radical progressive dynamic, where we shift to seize capital, and where there's-- it causes massive inflation. There's numerous ways. But the question at the end of the day is the average portfolio is only attenuated to this last 40 year period of growth. It's not about being afraid. It's about being prepared. So my parents, during the great financial crisis, they came out ahead because they had allocations to volatility in gold, and that saved them and allowed them to retire on time. I think the institutions, the large institutions and the average investors, if they can find ways to invest large portions in countertrend assets, not only will they get a better overall return profile and more safe return profile, but this will be a way for these institutions to be able to prosper during a period of secular change, rather than suffer. So I think this is a major-- it is more than a financial issue. It's a social issue. That these defensive assets, they're not for a rainy day. They're for a rainy decade. The problem that we face is not a problem of financial management or economics. It's a problem-- it's a social problem. It's an emotional problem. It takes a lot of social discipline and to think differently. Many of our leaders would rather fail conventionally with the herd than succeed unconventionally. DANIELLE DIMARTINO BOOTH: They're not Genghis Khan. CHRISTOPHER COLE: That's right. That's absolutely right. DANIELLE DIMARTINO BOOTH: It was great talking to you today. Thank you so much-- CHRISTOPHER COLE: Thank you. DANIELLE DIMARTINO BOOTH: --for being with Real Vision. CHRISTOPHER COLE: I had a great time.