Tuesday, June 2, 2015

A Disaster Waiting to Happen?

If you earn a state pension or live in a state that has a shortfall in their pension then you need to pay attention to pension obligation bonds.

Borrowing to Replenish Depleted Pensions

The idea is that a state issues bonds, borrowing money from bondholders, and invests the bonds in their depleted pensions.  To make the math work the pensions invest the money relatively aggressively and are projecting that they will earn more on the invested money than they will pay out on the bond interest.  If the next six years in the stock market look like the past six years then this will all end well.  If they don't, then it could make a bad problem really bad.  Kind of like what happens when you borrow from one credit card to pay off another credit card---usually things don't work out that well.

Nobody knows what the market is going to do, but we can learn a lot from history and at least judge the odds of this strategy being successful.  Looking at current stock market valuations based on historical standards, whenever US markets have been at this high a valuation the next 10 years have been mediocre at best.  One of the times when people start bringing out the this time is different argument they will be right, states better hope this time really is different.

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