In the 1900s, the average life expectancy for males in the U.S. was 46.3 years and 48.3 years for women. By 2018, the average had almost doubled to 80 and 84 respectively. While living longer may sound awesome, consider the financial implications of longevity. To do so, we need to delve into the dark, murky, and often misunderstood world of the actuary. After the dot.com bubble burst in 2000, I had the pleasure of leading a team of twenty actuaries in the financial engineering department of a life insurance company. It was not as much fun as it sounds. Actuaries build powerful mathematical models to predict mortality rates. Pension and healthcare companies use these rates to calculate how long they will need to support their customers financially. The longer people live, the greater the financial strain brought to bear on these companies. The longer you live, the more likely you will outlive your money.
Pensions became popular in World War II as a means to "pay" workers more due to salary freezes. Today, pensions are a multi-trillion-dollar industry. There are public pension funds and there are private pension funds. Public pension funds are regulated under public sector law while private pension funds are regulated under private sector law. In some countries, the difference is clear. In other countries, it is more nuanced in that private pensions are also regulated by public regulators. As of 2021, the largest pension fund was the Federal Old-Age and Survivors Insurance Trust Fund and Federal Disability Insurance Trust Fund (collectively, the Social Security Trust Fund or Trust Funds) managing $2.9 trillion. That is the nominal gross domestic product of the United Kingdom, the world's fifth-largest economy. The largest pension funds in the world collectively managed $18 trillion which is one trillion shy of U.S. gross domestic product.
Pensions are financial monsters. Up until the 1980s, most pensions were defined benefit schemes. They guaranteed a fixed payment to the participant on retirement. This was back in the day when doctors were endorsing cigarette brands, sunscreens were an item of furniture and we lived under the constant threat of the nuclear mushroom cloud. Also, interest rates were in double digits and pension fund managers did not need to be singularly talented to match their assets and liabilities. In 1987 and 2000, the markets taught us the painful lesson that crashes were no longer a once-in-a-generation occurrence. Financial engineering, derivatives, and technology injected new levels of volatility into markets which triggered red flags in actuarial models. Pension funds realized that it was dangerous to continue guaranteeing benefits in this volatile world and moved away from defined benefit to defined contribution schemes. This meant that retirement benefits were no longer defined by the pension fund's ability to generate returns. Benefits were now based on contributions. Pension funds waved the white flag and retreated like frightened hyenas with their tails between their legs.
How often have you come across the following advertising message from pension companies: “Most people will not have enough money for retirement - you need to start saving more and earlier? You need to live below your means and save more”. This is genius marketing. Fear is a powerful motivator. In fairness to the pension companies, this is not a ruse. Most people will outlive their pensions because the formal pension system is no longer capable of looking after the interests of their clients. Many blindly believe that the people managing their retirement savings know what they are doing. I spent 25 years in the finance industry, working in and with banks, insurance companies, and pension funds. Pension managers are underwhelming at best. The smart ones typically leave the mainstream organizations to start their own hedge funds and family offices. The mediocre ones stay and are looking after your money. Here is a list of reasons your retirement savings are not in the right hands and you need to make radical changes now.
Reason 1: Pension Fund Returns are in a Long Term Systematic Decline and are Heading toward ZERO
Investment management is a relative game. Performance is measured against a benchmark. If you do better than the benchmark you are rewarded. If you do worse, you are subject to a public lashing.
An African parable tells the story of two men walking through the bush. They come across a hungry lion. One man leans over and starts to tie his shoelaces. The other says there is no way he will be able to outrun the lion. The man tying his laces looks up at his companion and says: "there is no need for me to outrun the lion, I just need to outrun you".
In the modern pension world, consultants and regulators benchmark and compare the living crap out of fund performances. They publicly rank returns for all to see. It is a constant beauty pageant – the swimsuit competition where everything is laid bare.
To maintain their sanity, managers adopt a simple strategy: if they take too much risk, they are ranked top one month and bottom the next month. No one likes volatility. Investors want Goldilocks returns - not too hot and not too cold. The internal dialogue of a pension fund manager is as follows: "I will follow my peers and aim to be just above the middle of the pack. I will reduce my exposure to risky assets like equities and increase my exposure to less risky assets like bonds".
Bonds are also known as fixed-income instruments and are less risky than equities. Pension funds are the world's biggest buyers of bonds. Bond returns are linked to interest rates. In 1981, if you bought a freshly minted 10-year United States Treasury bond and held it until maturity, you would have earned 16 percent without any risk.
The United States Treasury bond is considered to be the safest financial instrument known to man. By December 2022, this yield had plummeted to 3.6 percent. This return is as exciting as a doctoral thesis on the lavatory habits of the Lithuanian pygmy gnat. You now need to understand the financial theory of the "least dirty shirt".
Finance is a relative game – you do not need to be smart or fast, you just need to be smarter or faster than your competitor. A return of 3.6 percent is low, but how does that compare with the rest of the world? In December 2022, most developed markets were paying less than 3.6 percent on their 10-year government bonds. Japan was the worst of the worse with a return of 0.25 percent according to Reuters. Japan was not the only country paying a yield below that of the US Treasury bond. There were several more including Switzerland, Germany, and France. And here was the joker that will kick you in the ribs. Greece, not known as the bedrock of financial stability, paid a return of 4.1 percent which was only 50 basis points above the United States Treasury. The financial world was more distorted and disfigured than in a Picasso painting. If we continue down this rabbit hole, pension returns will approach zero and will dip into negative territory. Your pension is going to get smaller and you will outlive your savings. You, therefore, need to rebel now.
Reason 2: Everyone believes Wall Street will Find a Solution
After law school, I was faced with two options: become a lawyer and make the world a better place, or become a banker and make the world a perfect location. My philanthropic subconscious caused me to choose the latter.
For me, the northern star was the trading and investment side of banking which is referred to as “Wall Street”. This world idolizes Gordon Gekko, in his suspenders, smoking Cuban cigars, swigging single malt, and living by the credo that greed is good.
I thought Wall Street was a collection of super-smart and successful individuals who shape and move world markets. I thought Wall Street was the "smartest" money in town. I wanted in on the action.
Then came the financial crisis in 2008 which almost led to the extinction of urbanized humanity. This may sound extreme but consider the facts: when Lehman Brothers collapsed, the global banking system almost froze. If an A-rated bank in the world's most regulated market could fail, what is the probability of smaller banks in less regulated markets going the same way?
When banks do not function, bread companies cannot buy wheat, and farmers cannot buy silage to feed their cows. Payments are made through banks. No banks mean no payments and no food. Urban humanity ends. What will New Yorkers do – go to the Central Park Zoo, shoot a grizzly bear, skin it, and then fire up the barbeque? I don't think so.
This fragility of urban survival built on credit cards and Whole Foods is the reason why cryptocurrencies exist. Santoshi Nakamoto – a person or group of people more camera-shy than the Loch-Ness monster - invented bitcoin and the blockchain.
Santoshi was terrified by the prospect of living in a world where life depended on dim-witted and greedy bankers who were not wired to make decisions for the greater good. Santoshi, therefore, created a currency that could operate outside of the formal banking system. Here is the Reader’s Digest version of what the financial crisis taught us about the people who have their filthy hands all over your money.
Lesson 1: Wall Street is Not the Smart Money
Do not be fooled by the fancy Swiss watches, Italian sports cars, and Hermes ties. Most bankers are untalented. Most Wall Street banks were on the wrong side of the 2008 financial crisis. They lost trillions of dollars and required governmental CPR. Howard Hubler (Howie to his friends) was the biggest loser. Howie was a bond trader at Morgan Stanley. He racked up losses of $9 billion – that is 9 with 9 zeros. That is a staggering amount of money for one individual. Given that finance is a zero-sum game (if Howie is losing 9 billion, somebody must be making 9 billion), where was the smart money amidst all this turmoil? The winners were eclectic hedge funds working under the radar in dark offices poring over CDO prospectuses, and Goldman Sachs – the one Wall Street bank that always comes out on top. Howie landed on his feet. After being fired from Morgan Stanley, he set up his own advisory firm into which investors with short memories invested more than $1 billion. A track record of success is not required for a career of raping and pillaging on Wall Street.
Lesson 2: Wall Street is Dishonest
The planet's most important financial index is LIBOR – the London Interbank Offered Rate. This index has nothing to do with London. It is the interest rate at which high-quality banks lend to each other in U.S. dollars.
In 2020, hundreds of trillions of dollars in bonds and swaps were linked to LIBOR. Every day they were valued based on the LIBOR fixing. Prepare for your minds to be blown. Market prices are set by market forces – supply and demand. Most interbank interest rates around the globe are set in this way, but not LIBOR. It is fixed daily based on a survey of 17 banks. Anyone with two fingers and a smartphone can set up a WhatsApp group chat with 17 people.
Dishonest bankers got together on WhatsApp and conspired to manipulate this LIBOR fixing. When the survey arrived, each bank knew exactly what the other 16 banks would say. This allowed them to set the fixings in their favor.
Regulators reacted quicker than bolts of lightning to address the situation. In 2021, 14 years after these nuggets of truth were revealed, LIBOR will be assassinated and replaced with the Secured Overnight Financing Rate (SOFR). Having the word "Secured" upfront means it will be impossible for Wall Street to manipulate.
Lesson 3: Wall Street is Infested with Conflicts of Interest
Wall Street specifically, and the financial community in general, is rotten to the core with conflicts of interest. When I was a trader, we had an ongoing joke about how the interests of the bank were always put before the client. If the client ever happened to get a good deal, it was purely coincidental and forgivable.
These conflicts of interest are particularly acute in the research that banks publish – the research on which many investors rely when making investment decisions. When a bank analyst recommends you buy a stock, the objectivity of the recommendation is always in question.
The bank may be doing corporate finance work for the company. This may cloud the judgment of the analyst. If a bank is underwriting the initial public offering of Uber, what are the chances of the analyst publishing a negative report on the company? There is a better chance of winning the lottery, having a threesome, and being struck by lightning in the same afternoon.
Conflicts of interest also live in the financial advice banks give to their clients. I sold a derivative hedge charging a 100 percent markup on the premium. The hedge cost 250,000 and I charged 500,000. I did this after hearing the client could not value the true value of the hedge. The client was the Catholic Church. There is a special place in hell for derivatives traders, next to Ted Bundy and Jeffrey Dahmer.
A client once said to me: "Ralph, you are a nice guy, it is always good to meet up with you, but going forward, I have decided to change my trading strategy. Every time your bank recommends to buy, I am going to sell". That client is now a multi-millionaire with a house in Monte Carlo. He recently got married to a Colombian supermodel and Beyoncé sang at their wedding.
You might say your pension is not run by a private pension firm, but by the government. The line between public and private pensions is sometimes vague. Generous employers contribute towards both a private pension and a public pension. Most public and many private pension funds are facing large unfunded liabilities because they are Ponzi schemes. In the world of Ponzi, new money is used to pay existing investors.
Bernie Madoff was the emperor of Ponzi - and is now spooning with a 400-pound felon in a prison cell. This is how the Principle of Ponzi is applied to a public pension fund. Assume that there are 1,000 participants in a pension scheme. Of these 1,000, 700 are economically active (i.e. they are working) and are contributing to the scheme and 300 are retired in Florida wearing socks and sandals and playing poker next to the pool. Money enters the pot every month from the 700 workers. Some of that money is used to pay the 300 to help them settle their gambling debts and guarantee a fresh supply of socks and sandals.
The remaining cash is used to run the scheme - administration, rent, salaries, telephone, high-speed internet for their Netflix streaming, and sundries. The money not spent on these essentials is invested in stocks, bonds, hedge funds, and alternative investments and makes up the assets of the fund.
For this scheme to keep working, more money must come in than goes out. This is where the wheels start to wobble. As population growth declines - as young couples prefer to backpack around the world and hug the trees in Bali instead of procreating - fewer new people enter the scheme.
Sometimes population growth slows down not because of tree-hugging but because of the government. The one-child policy in China comes to mind. The Chinese population will stop growing in 2024. In Japan, the undisputed leader in the inverted population pyramid, the market for adult diapers is larger than the market for infant diapers.
After a decade, only 100 newbies have joined the 700 swelling the number of contributors to 800. However, shortly after, 350 retired and head down to Del Boca Vista in Florida. We now have 650 in Florida and 450 contributing to the scheme. More money is flowing out than flowing in. The fund administrators need to draw on those reserves and government support to cover their unfunded liabilities. And who is better than the government to fill the gaps?
Governments have access to limitless resources. They control the printing press – Johannes Gutenberg is the patron saint of all central banks. They can print money - a power made exponentially more potent by the Nixon Shock. From a financial perspective, the Nixon Shock makes Watergate look like a game of hide and seek.
In 1944, the Bretton Woods system of monetary management pegged the major world currencies to gold. In 1971, Nixon unilaterally decided to move the United States dollar off the gold standard in the face of mounting inflation.
By 1973, the Bretton Woods system was replaced de facto by the current regime based on freely floating fiat currencies. Before 1971, you could take your paper money to the Federal Reserve and exchange it for gold. After 1971, you could take your money and replace it for the same money of the same value - just on cleaner paper. This is the Nixon Shock and marked the end of financial coherence.
Between 1971 to 2021, the United States M1 money supply (physical currency and coin, demand deposits, traveler's checks, other checkable deposits) grew from $400 billion to $19 trillion – an increase of 4,650 percent according to data from Trading Economics. This ability to print money represents a substantial disincentive to save. Savers are holding their wealth in pieces of paper that are continuously devaluing. Governments cannot keep printing money indefinitely to plug these pension gaps. A point of inflection will be reached, and this house of cards will come tumbling down. You do not want to entrust your retirement savings into this precarious paper system. You need to step up and take charge of your financial future now.