Thursday, September 23, 2010

A Downside of Low Interest Rates

Earlier this week, the Wall Street Journal ran an article discussing a somewhat hidden downside to the US economy's current ultra-low interest rates. That problem is what such rate levels do to assumptions driving pension fund values versus long term liabilities.

Simply put, companies- and states, for that matter- are facing much greater shortfalls in their pension funding. For example, the article cited GM sources as saying that "every .25 percentage-point decline in its discount rate could increase its pension obligation by about $2.4 billion."

That obligation as "underfunded by $17.1 billion at the end of 2009."

On a larger scale, the article noted,

"If S&P 500 companies took account of the interest-rate decline as of Aug. 31 to calculate their pension-fund balances, the combined deficit would increase by about $167 billion, or nearly two-thirds more than the year-end 2009 deficit of about $260 billion, estimates Jack Ciesielski of the research firm Analyst's Accounting Observer."

Leave it to the free market's checks and balances to identify this risk. Between suspect private sector growth rates inhibited by government interference, taxation and deficit policies, and these low interest rates, one wonders how any ground will be gained on these pension liabilities.

Down the road, of course, this could morph into lower demand and savings, as retirees don't collect expected pension payments.

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