I have not published one of these in quite some time but this news has me hearing the sound of time’s winged chariot hurrying near. Jack Bruce was the bass player and one of the founders of one of the legendary rock groups of the 1960s, Cream. He founded the group with drummer Ginger Baker and the incomparable Eric Clapton. He wrote and performed such classics as Sunshine of Your Love as well as White Room. That group was short lived but played spectacular music which gave unbounded pleasure to those who gloried ( and still glory) in the ethos of the era.
The original intent of IRA accounts back when the government first authorized them was that they would be long term assets and would supplement Social Security income for people in the great wide swath of middle incomes. This story relates how that idea has not held up over time and describes how many people use them to support current consumption.
This week, the Internal Revenue Service announced that people under age 50 in 401(k) and similar workplace retirement plans will be able to deposit up to $18,000 in 2015, an increase of $500 from this year. Those 50 and over can toss in as much as $24,000, a $1,000 increase.
Which is all fine and dandy for the well-heeled and the frugal. But one of the biggest problems with these accounts has nothing to do with how much we can put in. Instead, it’s the amount that so many people take out long before they retire.
Over a quarter of households that use one of these plans take out money for purposes other than retirement expenses at some point. In 2010, 9.3 percent of households who save in this way paid a penalty to take money out. They pulled out $60 billion in the process; a significant chunk of the $294 billion in employee contributions and employer matches that went into the accounts.
These staggering numbers come from an examination of federal and other data by Matt Fellowes, a former Georgetown public policy professor who now runs a software company called HelloWallet, which aims to help employers help their workers manage their money better.
In a paper he wrote with a colleague, he noted that industry veterans tend to refer to these retirement withdrawals as “leakage.” But as the two of them wrote, it’s really more like a breach. And while that term has grown more loaded since their treatise appeared last year and people’s debit card information started showing up on hacker websites, it’s still appropriate. Millions of people are clearly not using 401(k) plans as retirement accounts at all, and it’s a threat to their financial health.
“It’s not a system of retirement accounts,” said Stephen P. Utkus, the director of retirement research at Vanguard. “In effect, they have become dual-purpose systems for retirement and short-term consumption needs.”
How did this happen? Early on in the history of these accounts, there was concern that if there wasn’t some way for people to get the money out, they wouldn’t deposit any in the first place. Now, account holders may be able to take what are known as hardship withdrawals if they’re in financial trouble. Moreover, job changers often choose to pull out some or all of the money and pay income tax on it plus a 10 percent penalty.
The breach tends to be especially big when people are between jobs. Earlier this year, Fidelity revealed that 35 percent of its participants took out part or all of the money in their workplace retirement plans when leaving a job in 2013. Among those from ages 20 to 39, 41 percent took the money.
The big question is why, and the answer is that leading plan administrators like Fidelity and Vanguard don’t know for sure. They don’t do formal polls when people withdraw the money. In fact, it was obvious talking to people in the industry this week and reading the complaints from academics in the field that the lack of good data on these breaches is a real problem.
Fidelity does pick up some intelligence via its phone representatives and their conversations with customers. “Some people see a withdrawal as an opportunity to pay off debt,” said Jeanne Thompson, a Fidelity vice president. “They don’t see the balance as being big enough to matter.”
Or their long-term retirement savings matter less when the 401(k) balance is dwarfed by their current loans. Andrea Sease, who lives in Somerville, Mass., is about to start a new job as an analytical scientist for a pharmaceutical company. She was tempted to pull money from her old 401(k) to pay down her student loan debt, which is more than twice the size of her balance in the retirement account. “It almost seems like they encourage you,” she said, noting that the materials she received from her last retirement account administrator made it plain that pulling out the money was an option. “It’s an emotional thing when you look at your loan balance and ask yourself whether you really want to commit to 15 more years of paying it, and a large sum of 401(k) cash is just sitting there.” So far, she’s keeping her savings intact.
Another big reason that people pull their money: Their former employer makes them. The employers have the right to kick out former employees with small 401(k) balances, given the hassle of tracking small balances and the whereabouts of the people who leave them behind. According to Fidelity, among the plans that don’t have the kick-them-out rule, 35 percent of the people with less than $1,000 cashed out when they left a job. But at employers that do eject the low-balance account holders, 72 percent took the cash instead of rolling the money over into an individual retirement account.
This is unconscionable. Employers may meekly complain about the difficulty of finding the owners of orphan accounts, but it just isn’t that hard to track people down these days. Whatever the expense, they should bear it, given its contribution to the greater good. Let people leave their retirement money in their retirement accounts, for crying out loud.
Account holder ignorance may also contribute to the decision to withdraw money. “There is a complete lack of understanding of the tax implications,” said Shlomo Benartzi, a professor at the University of California, Los Angeles, and chief behavioral economist at Allianz Global Investors, who has done pioneering research on getting people to save more. “And given that we’re generally myopic, I don’t think people understand the long-term implications in terms of what it would cost in terms of retirement.”
In fact, young adults who spend their balance today will lose part of it to taxes and penalties and would have seen that balance increase many times over, as the chart accompanying this column shows.
But Mr. Fellowes of HelloWallet, interpreting the limited federal survey data that exists, says he believes that people raid their workplace retirement accounts most often because they have to. They are facing piles of unpaid bills or basic failures of day-to-day money management. Only 8 percent grab the money because of job loss and less than 6 percent do so for frivolous pursuits like vacations.
What can be done to change all of this? Mr. Benartzi thinks a personalized video might be even more effective than a boldly worded infographic showing people the money they stand to lose. He advises a company called Idomoo that has a clever one on its website aimed at people with pensions. If you want to see the damage that an early withdrawal could do, Wells Fargo has a tool on its site.
Fidelity has recently begun calling account holders to talk to them about cashing out, and it has found that people who get on the phone are a third as likely to remove some of their money as they are if they receive written communication. Here’s hoping more people will get such calls when they leave for another job.
Mr. Fellowes has a bigger idea. Given that so many people are pulling money from retirement savings accounts for nonretirement purposes, perhaps employers should make people put away money in an emergency savings account before letting them save in a retirement account. It’s a paternalistic solution, but some of the large employers he works with are considering it.
It’s surprising that regulators haven’t taken more notice of the breaches here. The numbers aren’t improving, but more and more people are relying on accounts like this as their primary source of retirement savings. “This is a problem that industry should solve,” said Mr. Benartzi, pointing to the unsustainability of tens of billions of dollars each year leaving retirement accounts for nonretirement purposes.
He says he thinks that there’s a chance that a company from outside the financial services industry could come in and solve the problem in an unexpected way before regulators take action. “If we don’t solve it, someone is going to eat our lunch, breakfast and dinner and drink our wine too.”
China’s economic growth is expected to be at 7 percent in 2015 unless the central government imposes stronger-than-expected stimulus measures, according to Fan Jianping, chief economist at a state research institute.
A decrease in exports and property development, two “engines” fueling China to be the world’s second-largest economy, will be the main cause of a slowing of growth, Fan, who works at the State Information Center under the National Development and Reform Commission, told an industry conference today.
Fan’s forecast is in line with a median estimate of 51 analysts in a Bloomberg News survey as Chinese leaders have signaled they will tolerate a weaker expansion, leaving the economy heading for the slowest full-year growth since 1990. Chinese leaders will set a gross domestic product growth target of about 7 percent for 2015, according to 13 of 22 analysts polled by Bloomberg.
“I don’t rule out that we will see on-year expansion lower than 7 percent in some single quarters next year,” Fan said. He said his forecast was based on his agency’s research, which uses China’s industrial production as a key indicator to the economic growth.
Fan’s remarks may cool down an improved sentiment in Chinese economy as GDP expanded by a better-than-forecast 7.3 percent in the third quarter from a year earlier. While the government has relaxed home-purchase controls and pumped liquidity to lenders, the economy also got support from a pickup in exports in September.
“In at least six months, economic growth is unlikely to pick up remarkably,” Fan said in Shanghai. GDP expansion in three months from October is seen at 7.2 to 7.3 percent, which will lead the full-year growth to about 7.3 percent as reading in the fourth quarter has bigger weighting, he said. China set 2014 GDP growth target at 7.5 percent.
China’s government is holding off broad stimulus, with Premier Li Keqiang expressing a preference for policy improvements and People’s Bank of China Governor Zhou Xiaochuan vowing to stick with a prudent monetary stance.
China’s premier typically announces the annual growth aspiration at the National People’s Congress in March, after policymakers meet late in the year at the Central Economic Work Conference to hash out policies.
China’s economic growth remained unchanged at 7.7 percent in 2013 and may ease to 7.3 percent this year, according to the median estimate of 51 analysts in a Bloomberg News survey.
Due to the pressure on the ECB to do QE, the rebound in US interest rates is underwhelming relative to the increase in stocks
US credit benefits from the rise in stocks while interest rate risks remains subdued. Longer term we remain more cautious…
…as interest rates go up and we enter the next phase of positive correlation between interest rates and credit spreads.
Spreads vs. rates. Stocks and interest rates continued to rebound this week as more US data – and corporate earnings – confirmed that the US economy is resilient to global weakness. However, as European economic weakness puts more pressure on the ECB to do QE, the rebound in US interest rates is underwhelming compared with the increase in stocks. That provides a continued favorable environment for US credit, as spreads benefit from the rise in stocks while interest rate risks remains subdued. Thus, while acknowledging that we are approaching the end of this trade, we retain our tactical long stance on US IG credit (see: One step forward, two steps back).
That means we continue to expect in the short term negative correlation between interest rates and credit spreads, as Treasuries catch up with the reality of strong US economic data. However, this is merely the recovery phase from the early October sell-off. Longer term we remain more cautious on credit, as interest rates go up and we enter the next phase of positive correlation between interest rates and credit spreads.
The textbook relation between interest rates and credit spreads is a negative correlation, as better (worse) economic news brings higher (lower) interest rates and lower (higher) credit spreads. However, after the financial crisis that fundamental correlation has turned positive, as the Fed’s zero interest rate policy lowered interest rates and created large and persistent inflows to credit. As interest rates now finally go up, we expect some of these inflows to reverse, and that eventually outflows will drive a continued positive correlation between interest rates and credit spreads over the next 12-18 months. Finally, when the flows situation stabilizes we return to the “normal” negative correlation between rates and spreads (Page 6)
The Yankee technical. Since the credit crisis US dollar bonds of European issuers have consistently traded wide relative to comparable bonds issued in Euros, even for the same issuer. Recently volatility has pushed USD / EUR spread differentials to the widest levels since the “taper tantrum” episode last year. We expect the diverging economic growth and corresponding opposite central bank policies to result in EUR IG spreads outperforming USD spreads going forward (see Breaking up is easy to do). While ECB easing directly benefits bonds issued in EUR, indirectly Yankee bonds of European issuers stand to benefit as well, as global credit mandates can arbitrage between spreads in the two currencies. (Page 13)
Rates, supply weaken bond technicals. Actual and expected supply combined with a sharp fall in interest rates has resulted in significant underperformance of cash relative to CDS. As interest rates increase, we expect the cash bonds to reverse the recent underperformance relative to CDS. However, heavy supply volumes, as companies exit earnings reporting season related blackouts, could limit this reversal..
Mortgages have seen limited activity today amidst light origination selling. FNMA 3 are lagging Treasuries by 3/4 / 32 . The 4s and 4.5s are outperforming by 1+ ticks.Fifteen year paper is lagging 30 year paper as REITS and money managers continue to be sellers.
As I made the rounds of market makers and portfolio managers this morning I find a tired group of people looking forward to the weekend. On the market making side traders report very light volumes today and little information in the types of trades going through or from the actors in those transactions. on both sides traders and portfolio managers lament the difficulty in trading in an Ebola world. It is not a variable which one can even remotely forecast.
The focus in the near term is the FOMC meeting next week. If I had to construct a consensus from my conversations I would say that participants look for a narrow range between 2.18/2.30 down to 2.18/2.20. If anything there seems to be agreement that in advance of the FOMC meting with the Treasury regurgitating supply that rates are likely to trend to the upper end of that range.
Regarding the FOMC participants expect the “considerable period ” language to survive. Some thought that given the last minutes and comments of several Committee members that the statement this time might include some reference to the global economy and FX considerations. That would be very dovish if those sentiments were enshrined in the statement.
IG CREDIT: List of New Issues Expected to Price in U.S. Today
2014-10-24 13:49:12.44 GMT
By Greg Chang
Oct. 24 (Bloomberg) — The following is a list of new
issues expected to price today.
* Credit Suisse, acting through its NY Branch $benchmark A1/A
* IPT +125 area
* IPT +125 area</li></ul>
* E.CL SA $350m (no grow) BBB/BBB
* Long 10Y (1/2025) 144A/Reg S without reg rights
* Guidance +235, +/-5 vs IPT +250 area
* Books: BofAML, C, HSBC
* Books: BofAML, C, HSBC</li></ul>
Swap spreads have leaked wider in the belly. One portfolio manager reports 5s and 10s are each wider by 1/4 basis point. The 2s and 30s are unchanged. He said that flow was minimal and he speculated that the belly widening resulted from the better bid in the Treasury market.
I note that Credit Suisse is selling a benchmark size issue in corporate bond land today. That is an issue which is likely to be swapped so on a quiet Friday that should limit the leakage wider in spreads.