Finance Memos - Discussing Personal Financial Decisions

Comments on the SVP debacle

High interest rates did not cause the SVB collapse because interest rates remain below their historic average. Management of SVB and possibly other banks failed to implement their core responsibility – matching the duration of assets and liabilities. Efforts to deal with bank insolvencies will lead to higher and more prolonged inflation.

Prologue: In 1991, the Treasury Department reviewed potential risks to the financial stability of Fannie Mae and Freddie Mac. A government model had concluded that the companies would not face problems due to an increase in interest rates until rates rose to the 24 percent or 28 percent level.

My review of this model found that the model understated interest rate risks for two reasons. First, the model omitted information about annual and lifetime payment caps on Adjustable-Rate Mortgages, which reduce bank revenue when interest rates rise. Second, the model did not fully consider the impact of interest rates on defaults and other outcomes that could exacerbate financial stress when interest rates rose.

A revised version of the government model that I put together concluded an interest rate shock in the 12-14 percent range would lead to financial problems for the two companies. Treasury officials were grateful for this input but were largely unconcerned because interest rates were on a downward trajectory.

The current generation of management at many banks takes extremely low interest rates for granted and understates risk associated, which exist when the duration of their asserts do not match the duration of their liabilities.

The 10-year Treasury interest rate a couple of years prior to the 2008 insolvency of Freddie Mac and Fannie Mae was around 5 percent, far lower than the interest rates that prevailed in most of the 1990s.

The 10-year interest rate at the time of the SVB debacle was around 4.0 percent and is now at 3.7 percent, below its historic average.

Comments

Comment One: Don’t blame the Fed or high interest rates for this debacle. High interest rates did not cause the SVP collapse because interest rates are not high as discussed in the post Should the Fed Pivot?

Comment Two: It is hard to understand why anyone, let alone a sophisticated financial institution with short term obligations, would tie up funds in long-term bonds when the yield on the 10-year government bond was lower than 1.0 percent during the pandemic and remains below the long-term average. More information on the type of investments that lead to this debacle is needed. Note, even short-term bond ETFs invested in inflation protection bonds like VIPSX, VTIP, and STIP, have lost substantial value in the past year. Go herefor a discussion a discussion of use of bond ETFs in a low interest environment. The collapse of a bank due to an interest rate exposure when the 10-year bond yield remained at 4.5 percent could have occurred if the bank’s analysts had grossly miscalculated the impact of interest rates on certain assets.

Bank officials purchasing these bonds and bond funds should have more carefully researched the impact of interest rates on all of their investments and realized there was more downside risk than upside potential from investing in fixed income assets when interest rates were at such a low

Comment Three: SVP may be the canary in the coal mine. The insolvencies of Freddie Mac and Fannie Mae were preceded by insolvencies of some smaller private mortgage insurers. The SVB closure occurred very quickly after the public became aware of the problems at the bank because there was a run for deposits. The First Republic Bank, is now losing deposits. Transparency causes depositors to flee but is necessary to assure better investments.

Comment Four: Regulators need to actively monitor a second potential stress point — crypto Ponzi schemes like the ones at FTX and Silvergate. Did crypto play a role in the SVB debacle? I wonder what impact if any exposure to crypto had on the SVB collapse.

Comment Five: The CEO of SVB sold $3.5 million in stocks prior to the sale of the bank. Federal regulators should move to claw back the proceeds of this gain.

Comment Six: The blame game has started. Republicans are blaming lax fiscal and monetary policy and have conveniently ignored their role. Yes, Jerome Powell should have increased interest rates sooner. However, there is a lot blame to be shared here. The Trump era tax cuts and Trump’s threats to fire Chairman Powell if he did not lower interest rates had a major impact on the nation’s fiscal and monetary condition. Also, Republicans have consistently argued for less regulation, a position that is hard to defend.

Comment Seven: The Fed is now in a tight box. Inflation and the labor market remain robust. A move by the Fed to prevent insolvencies, by lowering the cost of credit or by purchasing some of the long-term bonds owned by SVB, will lead to more inflation. Bill Ackman is making the case that SVB is too big to fail and the Fed should consider some sort of bailout. Dealing with the banking crisis could lead to higher inflation over a prolonged period.

The Choice Between Fixed Income Funds and Direct Purchases of Bonds

Whenever possible investors should seek out tax-preferred savings vehicles, which allow for direct investments into Treasury securities and hold Treasury bonds and notes instead of fixed-income funds. People saving for retirement or higher education can minimize risk by matching future obligations with specific bonds.

Introduction:

Many tax-preferred retirement accounts and 529 funds restrict investment choices to a small set of stock and bond ETFs or mutual funds. The allowable investments inside a 401(k) plan are selected by the plans sponsor. For example, the Thrift Savings Plan (TSP) offered to federal employees has several funds and an option for mutual fund investing but does not allow workers to purchase Treasury Securities directly through the Treasury or through a broker.

Most individual retirement accounts (IRAs) and brokerage accounts allow for direct investments in the stock of individual companies, Treasury securities, agency securities, and corporate bonds. Individual investors at Fidelity and Vanguard with an IRA account can purchase the same assets as investors with a brokerage account at the firm.

Individuals saving in plans that are not tax preferred can purchase bonds either through a brokerage account or through Treasury Direct. Series I savings bonds can only be purchased directly from the Treasury and are therefore not available for retirement savers or for people utilizing 529 plans for college savings.

Retirement savers with an IRA can purchase Treasury Inflation Protected Securities (TIPs) through their brokerage company. Whether this option is available through a 401(k) plan depends on the investment options chosen by the plan’s provider. Most 401(k) plans that I am aware of do not allow for direct purchases of TIPs.

Many financial advisors, including one mentioned in this CNBC article, favor the use of bond ETFs over direct purchases of Treasury securities. The prices of the bond funds touted in this article appear highly variable.

The use of bond funds instead of direct investments in bonds often results in inferior financial results. Both bond prices and bond ETF or mutual fund prices vary inversely with interest rates. The difference in financial exposure stemming from holding a bond and the financial exposure from holding a bond fund is that the bond holder can avoid losses by holding the bond until the maturity while returns for the holder of the bond funds are always dependent on interest rates.

All 401(K) plans have bond fund options. Many 401(k) plans have an option for short-term bonds that primarily invest in inflation protection securities. However, even short-maturity bond funds designed to protect investors from the eroding effect of inflation can result in substantial financial losses for investors.

The returns for VIPSX are -10.45 % over a one-year holding period and 1.02 percent over a 10-year holding period. Other short-term bond funds seeking to protect investors from inflation including STPZ and VTIP do not appear to be meeting their objective in the current macroeconomic environment.

There is one sure fire way to insulate your portfolio from inflation, the purchase of Series I bonds. However, the IRS imposes an annual limit on the purchase of Series I bonds, and Series I bonds cannot be purchased in IRAs, 401(k) plans or 529 plans. Most household with most of their financial portfolio inside a retirement plan cannot purchase enough Series I Savings bonds to insulate themselves from inflation.

The performance of both long-term Treasury bonds and bond funds has also been miserable. See BND, AGG, and FNBGX and look at the chart with the longest time span of historical prices.

Advantages of Direct Investments in Treasury Securities:

Investors who purchase a Treasury security at a positive yield and hold the Treasury security to maturity will never experience a nominal loss on the security.

However, many investors will sell a long-term security prior to its maturity.

Investors should not purchase either a long-term bond or a long-term bond fund when interest rates are extremely low, as they were during the pandemic, since at that time interest rates were certain to rise and bond prices certain to fall.

Investors can spread out bond purchases over several months to assure monthly access to liquid retirement assets. The purchase of six-month Treasury bills on six consecutive months would allow for monthly access to liquid assets.

The price risk of a Treasury security goes towards zero when the security nears its maturity date. An investor needing funds shortly before the maturity date could sell the asset without a substantial loss, even if interest rates rise. By contrast, short-term bond funds have no maturity date, hence the price of the fund will fall if interest rates rise.

Investors can match the maturity of bonds that they hold with future liabilities. This is an especially important feature for parents saving for college tuition who could match bond maturities with tuition payment due dates.

However, 529 plans commonly used for saving for college generally do not have an option allowing for direct investments in Treasury securities. Instead, the plans allocate investments into bond and stock ETFs or mutual funds. The price of funds inside college 529 plans, even the short-term bond funds, vary substantially with market conditions.

Both savers in 529 plans and savers in retirement plans often save through a life-cycle fund that shifts assets from stocks to bonds as investors near retirement. However, the component of the Lifecycle fund invested in a bond portfolio will fall in value when interest rates rise.

Both bond and stock funds fell in tandem during the past year. Lifecycle investing did not protect investors during the latest market downturn.

Most retirees put all funds in instruments without a maturity date and base disbursements on a guideline like the four percent rule. The four percent rule is not going to work if the value of both your stocks and bond funds simultaneously declines as they did most recently.

Retirees could and should purchase Treasury bonds and schedule the maturity of the bond for different dates each year. The retiree would even consumption and reduce depletion of retirement assets by consuming from maturing bonds when the stock market is low and consuming from stock ETF distributions when the stock market is high.

Retirees with assets in bonds that mature on specific dates are better prepared for retirement than retirees with assets that have all savings tied up in funds without maturity dates.

Concluding Remarks: The tax code provides preferences for investments in tax-preferred retirement accounts and 529 plans. Congress recently passed legislation mandating automatic contributions to 401(k) plans. Financial advisors strongly recommend use of these tax-preferred savings vehicles.

Tax preferred savings vehicle often have limited investment options.

Tax-preferred savings plans often do not allow for the direct purchase of Treasury or government agency fixed-income securities with specific maturity dates, which could be matched with spending obligations.

Moreover, financial advisors often advocate the use of bond funds instead of bonds with specific maturity date.

Congress, through the tax code and their mandates and financial advisors through their insights guide investors to suboptimal higher-risk financial choices.

David Bernstein an economist living in Denver Colorado has written extensively on health and financial policy including a recent article outlining a 2024 Health Care Reform Proposal and an evaluation of President Biden’s student debt discharge proposal.

Evaluating the Biden Administration Student Debt Discharge Proposal

The Biden Administration student debt discharge proposal is being challenged in the courts and may be overturned. This one-time debt relief proposal does not change the trajectory towards higher student debt burdens. A credible case can be made for student debt relief to prevent a shock to consumption when student loan payments are reinstated. However, the proposal is arbitrary in who it assists and is not the most economically efficient or fairest way to address the pending economic shock from the reinstatement of student loan obligations.

The student discharge proposal:

The Biden Administration is proposing a one-time discharge of federal student debt. Borrowers with a Pell grant can have up to $20,000 discharged. Borrowers with a federal loan that were not eligible for a Pell grant could receive a loan discharge of up to $10,000. The amount discharged cannot exceed the amount of the loan.

Taxpayers with income less than $125,000 (single filers) or $250,000 (married filers) are eligible for the one-time debt discharge.

Student loans taken out after June 20, 2022, are not eligible for the loan discharge program.

Six states have brought litigation to stop the Biden Administration student discharge program on grounds that the Biden Administration exceeded their legal authority and that the law damages institutions in their state. The Biden Administration claims their authority to provide student loan debt relief due to COVID stems from the 2003 Heroes Act which allows for relief under a national emergency and that the plaintiffs do not have standing to litigate this issue. The Supreme court has agreed to rule on this matter and the debt discharge proposal has been stayed pending the decision.

Some issues with the Debt Discharge Proposal:

Opponents of proposals to discharge student debt argue the programs are regressive because people with access to education due to their student loans will earn more over their lifetime than workers who never go to school. This view was espoused by the moderate candidates in the 2020 Democratic primary including Joe Biden.

The student loan debt relief package is a one-time benefit. It only favors people with debt incurred prior to June 2022. It does not benefit future student borrowers. It does not change the trajectory toward higher debt burdens for future cohorts of student borrowers.

The absence of debt relief for people taking out student loans after June 2022 is necessary because the legal justification of the program is the COVID emergency. It would be difficult to maintain that people taking out loans after June 2022 needed financial assistance because of COVID, at a time when all other COVID relief packages were ending.

The Biden Administration attempts to ameliorate concerns that student debt relief favors high income professionals over workers by imposing income limits on eligibility for the debt discharge and by having a larger level of debt discharge for people who initially had income low enough to qualify for a Pell grant. These arbitrary provisions don’t lead to the program automatically targeting the student borrowers who are most in need of assistance.

Income is highly variable, especially at the beginning of a person’s career. The need for the loan discharge depends on salaries over many years not salary in one arbitrary year.

A person starting her career in the year of the discharge at a modest starting salary would automatically receive the discharge. A person three years advanced on the same career path might not receive any financial assistance if her salary has risen. For example, the debt discharge will be available for a doctor who is a resident during the year of the debt discharge program but will be unavailable for an attending physician.

A person leaving a high-powered job a year (a law associate who does not become partner) after the financial discharge provision would not receive any financial assistance despite the decrease in salary.

Many medical students who take on hundreds of thousands of dollars of debt may be more deserving of a debt discharge than students with less debt and lower debt burdens.

The person who received a Pell grant may be better off than middle-class people who are ineligible for the Pell grant when the loan was granted.

The Biden Administration claims that the Heroes Act of 2003 gives the Administration the right to modify student loans in the case of a national emergency. The plaintiffs in this case are arguing that relief offered the proposal is broader than what is allowed under the law and that the COVID emergency was only a pre-text for the program.

The Biden Administration argues that without debt relief there will be a historically large increase in delinquencies and defaults. A less expensive way to reduce defaults might involve freezing interest payments and reducing monthly minimum payments for a year or two after reinstatement of loan payments. However, the Heroes Act does not state that financial relief must be offered in the most efficient way.

No one knows how the Court will rule. The Court is not well equipped to deal with the economic aspects of this issue. Congress has other levers, including the budgetary process and the debt limit, to force changes to the program.

The one-time debt relief proposal is at best a band aid. It does not address the continuing acceleration in college costs and student debt. The debt discharge proposal is only one component of the Biden Administrations efforts to assist student borrowers. Other programs including revisions to Income Driven Replacement (IDR) and some waivers for the discharge of current IDR loans will be addressed in a future post.

David Bernstein is the author of A 2024 Health Care Reform Agenda and Alternatives to the Biden Student Debt Plan.

Insurance Company Abuse of the Medically Necessary Decision

Health Insurance companies often deny benefits for health services that they deem medically unnecessary even when there is no other option and even when the option may be cost effective in the long term. This post examines insurance company abuse of the medically necessary determination and potential policy responses.

Background: Insurance company denials of claims based on the view that the procedure is not medically necessary is widespread and can involve serious life-threatening health care cases.

This Kaiser Family Foundation article shows many requests for benefits are denied and the denials for medical necessity are seldom challenged.

A denial based on the view that a procedure is medically unnecessary can occur when a patient is in great pain and faced with a life-threatening condition. This ProPublica article describes a decision by United Heath Group to deny the only viable treatment for a patient suffering from a severe case of ulcerative colitis.

Symptoms of the disease for this patient included severe arthritis, diarrhea, fatigue, and blood clots. The medical bills were running $2.0 million per year. Bills of this magnitude are not unusual for new biologic drugs. The expensive drugs were the only therapy that worked. The patient could not function and would die without the treatment.

The family responded with a lawsuit, which revealed that employees at United Health Group misrepresented findings and ignored warnings from doctors about risks of altering an expensive drug treatment.

The amazing ProPublica article, reveals that insurance companies will basically lie to avoid expensive claims. The denial in the ulcerative colitis was motivated by the cost of the drug. The insurance company was willing to lie and commit fraud to avoid paying for the expensive treatment.

Insurance companies will also resist making claims when a procedure is economical in the long term. For example, insurance companies have denied patients access to the Coflex medical devise for spine surgery even though there is evidence that the procedure is safe and actually cost effective compared to other procedures.

The denial of benefits in the Coflex device decision was motivated by a desire to force or encourage people with expensive back problems to switch to a different more expensive insurance plan. This process of tailoring benefits away from people who are likely to be big health care spenders or denying benefits for expensive health conditions is a practice call “Cherry Picking.”

Policy Implications: The ACA eliminated lifetime and annual health expenditure limits under insurance plans. Insurance companies responded by restricting access to care and by deeming more procedures medically unnecessary.

One response to this problem might be to move the decision on whether a process is medically necessary to an independent board outside of the insurance company. I doubt this would work.

Most people currently don’t appear adverse decisions and insurance companies have much more resources for the appeal process. However, moving the appeals process to an external board might speed up decisions and encourage more people who are denied benefits to appeal the decision. A streamlined appeals process can be extremely important when the patient has been approved for a less expensive option but is appealing for access to the newer potentially better procedure. (This occurs with denials of access to the Coflex medical devise because patients are often approved for a less expensive, less effective surgery that does not involve use of the device.)

A second more practical approach is to have government pay part of the cost of the most expensive health care procedures through a reinsurance program. I might have government pay 50 percent of all health care costs over $100,000. This type of cost-sharing arrangement would result in several benefit – including lower premiums and tax expenditures on the private health plan, decreased demand for short-term health plans that do not provide comprehensive coverage, and a reduction in claim denials.

An increased use of expensive biologic drugs will lead to either higher denials as discussed in the ProPublica article or higher health insurance premiums. This problem can only be resolved by a partnership where the costs of these high-cost cases is shared with taxpayers.

My first paper on the use of reinsurance to improve health insurance options and increase access to health care can be found here. A cost-sharing program is part of my 2023 Health Care Reform proposal. Go here for a quick outline of the proposal.

The Abortion Debate After Dobbs

The abortion debate is more complex after the Dobbs decision. Women with life-threatening health conditions are being denied access to medical care and Republicans are seeking new restrictions on reproductive rights. Democrats need to do more than just assert support for abortion. They must outline how repeal of abortion has endangered the health of many women, the new legal threats to reproductive rights, and the steps they want to take going forward.

Introduction:

In the recent State of the Union Address President Biden called for Congress to pass legislation that would reinstate the abortion rules under Roe v. Wade. This is unlikely to happen in the new Congress because Democrats lack control of the House and are unable or unwilling to break a filibuster in the Senate.

President Biden did not outline the impact of the Dobbs decision on women’s health and the new Republican initiatives to further restrict reproductive rights. The complex post-Dobbs abortion debate deserves a more complete or robust response.

Abortion Issues After Dobbs:

Issue One: Women are not receiving necessary health care, when their life is in danger, or they have a miscarriage.

There are many examples of women who nearly died or had suffered from lack of access to medical care because of new abortion laws.

Here are links to some articles on women being denied access to adequate medical care because of laws restricting access to abortion.

https://www.yahoo.com/now/ohio-woman-denied-emergency-abortion-014000108.html

https://www.cnn.com/2023/02/08/health/ohio-abortion-long/index.html

https://www.independent.co.uk/news/world/americas/idaho-woman-abortion-ban-treatment-b2254982.html

https://www.cnn.com/2022/11/16/health/abortion-texas-sepsis/index.html

https://khn.org/news/article/bleeding-and-in-pain-a-pregnant-woman-in-louisiana-couldnt-get-answers/

https://slate.com/news-and-politics/2022/05/roe-dobbs-abortion-ban-reproductive-medicine-alabama.html

Issue Two: There is a lot of litigation involving restrictions of mifepristone, a medicine that provides an abortion early in a woman’s pregnancy. These cases could easily end up at the Supreme Court.

Here are some articles on these cases.

https://www.cnbc.com/2023/02/10/abortion-pill-judge-extends-deadline-in-lawsuit-seeking-to-pull-medication-from-us.html

https://www.cnbc.com/2023/02/02/gop-attorneys-general-warn-cvs-walgreens-against-mailing-abortion-pill-in-their-states.html

https://www.cnbc.com/2023/01/25/abortion-pill-genbiopro-sues-west-virginia-argues-fda-pre-empts-state-ban.html

Issue Three: States are considering banning inter-state travel to obtain an abortion.

Can states punish women for traveling out of state to get an abortion?

Issue Four: Many prosecutors are refusing to prosecute women or providers who violate state abortion laws. Some governors and legislators want to eliminate prosecutorial discretion and remove some duly elected pro-choice prosecutors.

Here are some articles:

https://www.vera.org/news/the-prosecutors-refusing-to-criminalize-abortion

https://www.politico.com/news/2022/06/26/blue-city-prosecutors-in-red-states-vow-not-to-press-charges-over-abortions-00042415

https://www.bloomberg.com/news/articles/2023-01-20/desantis-wins-battle-with-prosecutor-ousted-for-abortion-stance

Concluding thoughts: The Democrats need to do a lot more than assert they want to restore Roe. Democrats need to react the threats and anguish that exist in the world because of Dobbs.

A political advertisement that says “my opponent opposes abortion so vote for me” is not enough. Democrats, to be successful, need to discuss the way that Roe is creating misery, how things could get even worse, and outline the actions they are taking on each aspect of the abortion debate.

David Bernstein is the author of A 2024 Health Care Reform Proposal on Kindle and on Sell Wire. Also, this manuscript on long term care insurance, while a bit dated, provides a valuable perspective that differs from the insurance industry line.

Bring Back the Jackson-Vanik Approach to Russia

Many policy makers want to give Russia an exit ramp from the war. The existence of the exit- ramp option, gives the aggressor an incentive to continue hostilities because if events on the battlefield go poorly the aggressor can take the ramp. The United States and NATO need to convince Putin that consequences from this aggression cannot be easily reversed. Targeted economic sanctions have not caused western businesses to leave Russia. The key to resolution of the war in Ukraine is a difficult-to-reverse restriction on economic activity with Russia patterned after the Jackson-Vanik Amendment.

Background on the Jackson Vanik Amendment:

The Jackson-Vanik Amendment to a Trade Act passed in 1974 restricted trade with non-market economies that restricted Jewish emigration and violated other human rights groups.

The Jackson-Vanik restrictions on trade were repealed in 2012 in the same law that imposed trade sanctions on some Russian officials for the murder of Sergei Magnitsky. The repeal of Jackson-Vanik led the United States to grant most favored nation trade status to Russia and Russia was granted entry to the WTO in August of 2012.

Russia remains a member of the WTO in good standing despite Russian involvement in the downloading of civilian airliner over Ukraine, the invasion of Crimea in 2014, and the current war in Ukraine.

The Current Situation:

Russian aggression and genocide In Ukraine haven’t been prevented by targeted sanctions that would be easily reversed. Go here for a discussion of child abductions by Russia in Ukraine. Go here for a discussion of Russian war crimes since 1991. Go here for a discussion of recent civilian casualties in Ukraine.

Economic sanctions have not prevented many western nations from continuing business in Russia as discussed here.

The appeasement advocates claim to be motivated by fear of a wider conflict. There already is a wider conflict. Russia committed human rights violation in Georgia, a regime that jailed its former president. Russia supports the dictator in Belarus. Go here for an article on Belarus.

Bring Back Jackson Vanik:

Targeted economic sanctions have not affected Russian behavior.

The linkage of the Magnitsky sanctions to the repeal of Jackson-Vanik did not deter Russian aggression. On balance the combination of the repeal of Jackson-Vanik with the enactment of Magnitsky sanctions was a good deal for Russia.

The WTO claims that it contributes to peace and stability. Let’s be clear. Russia’s entry into the WTO did not contribute to peace and stability.

Despite sanctions, western firms have not left Russia. The western firms and the Russian government both believe sanctions can be largely ignored and will be reversed.

Only Congress and the Administration working together can send a signal to the Russians that they will not get away with aggression and crimes. The way to do this is to abolish most favored nation trade status, remove Russia from the WTO, and prohibit trade and investment with Russia until Congress passes legislation removing these penalties.

A key to ending the Ukraine war and deterring future Russian aggression involves broad penalties imposed on the entire Russian economy not narrow sanctions on the elite who will be compensated for their sacrifices.

A successful deterrent strategy requires penalties that cannot be reversed unless there is proof supporting the view that the aggression will end and will not be repeated.

We need a return to the Reagan philosophy of Trust but Verify. A law similar to the Jackson-Vanik Amendment is a first step in instituting this approach.

David Bernstein is the author of A 2024 Health Care Reform Proposal.

A 2024 Retirement Security Agenda

Pension and Social Security reform are inextricably linked because many retirees are highly dependent or Social Security, many workers nearing retirement are not in good financial shape and young adult are spending retirement funds early in their career. The recently enacted Secure Act 2.0 does very little to assist workers who are having the hardest time saving for retirement. Republicans and Democrats are far apart in their ideas on how to fix Social Security and neither party recognizes that meaningful enhancements in private retirement savings are essential to a successful Social Security reform. This post discusses ways to fix both the private retirement system and Social Security.

Introduction:

Many American workers are not preparing well enough for retirement.

Around half of older workers do not have any funds in a defined contribution plan (401(k) or IRA.)

The median amount of retirement assets for people with retirement plans is around $109,000.

Around 13.7 percent of the 65-and-over population lives in poverty.

More older workers are entering retirement with mortgage debt or consumer debt.

Many older workers cannot remain in the workforce because of poor health.

Economic downturns tend to result in a larger increase in unemployment for older workers than for younger or middle-aged workers.

Around 40 percent of older Americans are entirely dependent on Social Security.

Current law links future Social Security payments to the balance in the trust fund. Projected decreases in the trust fund would lead to a 20 percent in Social Security benefits in 2035, barring changes to the trust fund or current law.

Nearly 60 percent of young workers between the ages of 18 and 34 have already taken funds out of their retirement accounts to maintain current spending. Early disbursements from retirement plans by young adults are especially high for people with high levels of student debt.

The traditional 60/40 portfolio held by many retirees loses substantial value in a period where the stock market falls, and interest rates rise.

Congress and the Administration have not prioritized retirement income issues and are not close to addressing the looming Social Security problem.

Documenting the lack of progress:

Our leaders are not moving us forward on efforts to increase private savings for retirement or on efforts to fix the looming Social Security problem.

Congress has passed some legislation, most recently, the Secure Act 2.0, impacting savings through 401(k) plans and IRAs. Unfortunately, the recently enacted law does more to benefit investment firms and high net-worth savers than the workers who are struggling the most to save for retirement. A more complete description of the Secure Act 2.0 can be found here and some of its shortcomings are listed below.

Delays in implementation of Required Minimum Distribution do not assist retirees with low levels of retirement assets, people who tend to deplete their retirement accounts early in their retirement. Provision increases fees received by investment firms.

Shorter waiting period for participation in 401(k) plans does not shorten vesting requirement and may benefit relatively few workers because many part-time workers do not stay at the same firm for a long time.

A provision clarifying that employers can contribute matching funds to 401(k) plans for student loan payments does not assist workers at firms without a 401(k) plan or firms with a 401(k) plan that do not match employee contributions.

The automatic 401(k) enrollment provision and automatic increases in contribution will reduce savings through other vehicles and will lead to relatively little additional savings if funds are distributed prior to retirement.

Around 40 percent of retired households are totally dependent on Social Security and many more are highly dependent on Social Security. Expansion of private retirement spending is important by itself and has major implications for Social Security reform efforts.

The implementation of some Social Security reform proposals that would lead to abrupt changes in benefits could not be applied to workers nearing retirement without causing large increases in poverty among the elderly.

The Social Security trustees project that automatic benefit cuts to Social Security could occur in 2035 and that automatic Medicare benefit cuts could occur as early as 2028.

Democrats and Republicans are wide apart on what needs to be done to prevent automatic cuts to entitlement programs. Democrats stress the need for additional revenue. Republican proposals often call for large benefit cuts, many of which are applied to workers nearing retirement.

One proposal that could receive some bipartisan support inside a larger package involves increasing the cap on wages subject to Social Security taxes. Current rules apply Social Security taxes to the first $160,200 of wages. Go here for a discussion of proposals to eliminate or modify the cap on Social Security taxes.

Republicans tend to favor plans to reduce benefits, raise the retirement age, and create private accounts to replace all or part of the current Social Security system. Some of the Republican proposals discussed herewould result in quick changes impacting potentially impacting workers close to retirement. For example, a proposal to increase the retirement age for full Social Security benefits by 3 months per year until 2040, when the full retirement age reached 70 would result in substantial poverty among the elderly because private retirement savings could not be increased in this time frame.

Timely changes to Social Security are essential to prevent automatic benefit cuts that would lead to large increases in poverty because of the lack of private retirement savings.

Reforming private retirement savings:

Reforms of private retirement savings that expand savings for low-income and middle-income households are a prerequisite for meaningful Social Security reforms because so many households are dependent on Social Security.

There are six problems preventing workers from accumulating sufficient retirement savings prior to retirement. Steps must be taken to address each problem.

First, workers are free to disburse all entire savings from their 401(k) plans prior to retirement. Around 60 percent of young workers have tapped part of their retirement savings prior to age 34. Steps must be taken to restrict pre-retirement disbursements from retirement plans and to incentivize workers from reducing retirement savings prior to retirement.

Proposed policy changes to address pre-retirement leakages from retirement accounts include:

Prohibit pre-retirement distributions from retirement plans for 25 percent of all contributions. The prohibited distributions could be used to purchase an annuity that would not pay out until the retiree reaches a certain age.

Require automatic rollover into IRAs for all workers making a job transition with 401(k) balances less than $50,000. (Current law allows but does not require automatic rollovers.)

Prohibit loans from 401(k) plans. Replace loans with limited tax-free and penalty-free distributions from the newly created emergency funds inside a 401(k) plan.

Second, workers reliant on Individual Retirement Accounts (IRAs) have less generous saving incentives than workers with access to employer-based 401(K) plans. Workers dependent on an IRA without access to a 401(k) have a lower contributions limit, do not have access to an employer match, and do not have access to retirement incentives for student loan payments.

Proposed changes to rules that reduce or eliminate discrepancies between savings through IRAs and savings through 401(k) plans include:

Create automatic contributions to IRAs for people without access to employer-sponsored 401(k) plans, patterned after the rules that are currently applied to automatic enrollment into 401(k) plans.

Change tax law to allow for employers to make matching contributions to worker contributions to IRAs like the ones currently allowed for 401(k) plans.

Equalize IRA and 401(k) contributions limit and deductibility limits on IRA and 401(k) contributions.

Change tax law to allow tax-free contributions to IRAs by firms hiring contractors or gig workers instead of direct employees.

Third, the current tax preference for contributions to 401(k) plans and deductible IRAs favors higher income people with higher marginal tax rates. Tax savings from expenditures from Roth IRAs in retirement also disproportionately benefit higher-income taxpayers. Income related gap in subsidies could be altered by changes to the tax code.

Replace existing tax exemption for contributions to traditional 401(k) plans and the tax deduction for contributions to deductible IRAs with a tax credit.

Create a tax credit for first $2,000 contributed to a retirement plan and allow tax deduction for additional contributions up to a cap.

Fourth, many workers are now diverting retirement savings to health savings accounts and flexible savings accounts to pay for health expenses that are no longer covered by health insurance. This is a growing problem due to the growing use of high-deductible health plans.

Proposed policy changes to offset the loss of retirement income due to the growth of cost-sharing between insurance companies and insured households include:

Allow for the use of health savings accounts for people with lower deductible health plans to reduce the need for large contributions to health savings accounts.

Change rules governing flexible savings account to allow people to place unused flexible savings account funds in a 401(k) plan or IRA rather than lose the unused funds. It would be appropriate to tax funds transferred from a flexible savings account to a retirement account.

Fifth, fewer than 15 percent of retirees have an annuity inside their retirement plan. The primary reason for the low level of annuity income is the cost of annuities.

Mandate that 25 percent of funds contributed to a retirement plan be used to purchase an annuity.

The source of funds for the mandatory annuity purchase could be the funds the person is not allowed to disburse prior to reaching retirement age.

The rule requiring all workers make an annuity purchase would lower annuity prices because voluntary annuity purchases are favored by healthy people with long life expectancy.

Sixth, retirees often suffer when inflation erodes the value of bond and stocks. Many workers cannot afford to save much outside their retirement plan and current tax law does not allow individuals to purchase series I bonds inside a 401(k) plan or an IRA. Many assets inside a 401(k) plan that proport to be inflation hedges lose value in an inflationary or high interest rate environment.

The most effective way to prevent reduction in retirement plan wealth in a period when inflation and interest rates rise, and stock prices fall is to allow and encourage the purchase of Series I savings bonds inside a 401(k) plan or IRA. Series I savings bonds never fall in value and have substantial upside in an inflationary environment. Go here for a discussion of advantages of Series I Savings Bonds.

The primary effect of the current restrictions on Series I Savings bonds is to increase the demand for financial assets and ETFs that are less effective in protecting investors from inflation than Series I Bonds.

Reforming Social Security:

The expansion and improvement of private retirement savings options will reduce dependence on Social Security by future generations and allow for the consideration of a broader range of Social Security reform options including eventual reductions in benefits.

The Social Security reform measures considered here include:

A new tax earmarked for Social Security and Medicare. The tax would be imposed on all forms of income and would have a progressive tax structure.

Increase in both the minimum retirement age for Social Security benefits and the age for full benefits, by one year each phased in over a 24-year period with a one month increase in the retirement age every two years. The age at which people receive the maximum allowable Social Security benefit would remain unchanged.

Guarantee future Social Security benefits by allocating some general tax revenue towards future benefits if the Trust fund balance falls to a certain level.

Economic Notes on the Policy Package:

The combination of tax credits to stimulate private retirement savings, tax increases to fund current Social Security and Medicare benefits and long-term increases in the retirement age create a healthy macroeconomic environment and will lower household financial distress in retirement.

Short-term changes in tax revenue will be modest because losses in tax revenue from tax credits to stimulate private retirement savings are offset by increases in tax revenue from the new tax to maintain Social Security and Medicare benefits.

The phased in increases in the retirement age will not have an immediate impact on government deficits but will reduce future Debt-to-GDP ratios. Since markets are forward looking the projected lower future debt burdens will have a beneficial impact on asset prices even if near term deficits rise.

The tax base to continue funding Social Security and Medicare benefits should be relatively broad. The tax could be imposed for all households making more than $50,000. The tax would be progressive. The marginal tax rate might range from 0.5 percent to a cap of 5.0 percent. The tax would be applied to both wages and investment income.

Concluding Remarks: Unless changes are made to rules governing Social Security and Medicare there will be automatic benefit cuts once trust funds assets are partially depleted. Many Republicans favor large and abrupt changes to Social Security benefits and the retirement age. Any abrupt change in benefits would have an extremely adverse impact on household poverty and on aggregate demand.

A reduction in Social Security benefits that is not preceded by a substantial expansion in private retirement savings by the workers who are now having the most difficulty saving for retirement would lead to catastrophic financial impacts for many households. This outcome can only be avoided by coupling private pension reforms with Social Security reforms.

David Bernstein is the author of A 2024 Health Care Reform Proposal.

A 2024 Health Care Agenda

Progress on health care and health insurance appears to be two steps forward followed by one step back. This memo outlines ongoing health insurance problems and proposed solutions.

Introduction:

The ACA reduced the number of people without health insurance coverage by creating state exchange health insurance markets and expanding Medicaid coverage. The Biden Administration expanded the premium tax credit for state exchange insurance and facilitated additional continuous Medicaid coverage. However, the Biden-era reforms will lapse.

The enhanced premium tax credit will remain in place through 2025. A Covid-era program facilitating continuous Medicaid coverage expires April 1, 2023.

Many health insurance and health care problems persist. Some appear to be worsening.

Cost sharing, including deductibles, maximum allowable out-of-pocket limits, and coinsurance rates, for people with comprehensive health insurance coverage has increased for decades.

People with employer-based health insurance are still susceptible to a loss of health insurance coverage, increased premiums, and additional out-of-pocket costs during job transitions. Loss of coverage and increase uninsured costs will still routinely rise during recessions.

Middle-income adults with state-exchange insurance still pay substantially higher premiums than middle-income adults with employer-based health insurance.

Workers at firms with relatively few health insurance options are usually ineligible for the premium tax credit for state exchange insurance and are often locked into a policy that is not best suited for their needs. (The Biden administration did eliminate the family glitch impacting the affordability of family-plan state-exchange policies. However, many families with an offer of employer-based insurance are still precluded from claiming the premium tax credit for state-exchange policies even when the state-exchange policy is superior to the employer-based policy.)

Many households unable to afford comprehensive health insurance have purchased short-term junk insurance policies that leave them de-facto uninsured and exposed to high medical expenditures.

Despite passage of the no-surprises act many households are still receiving bills from out-of-network providers, especially out-of-network specialists at in-network facilities.

Many narrow-network health insurance plans do not provide sufficient access to top hospitals or specialists.

The memo outlines potential policy responses to these health insurance problems. A more in-depth discussion of the problems and proposed solutions can be found in A 2024 Health Care Reform Proposal available at Sellwire and at Kindle.

Potential 2024 Health Care Policy Proposals:

Proposal One: Modify Rules Governing Health Savings Accounts and Flexible Savings Accounts to mitigate problems associated with higher cost sharing between insurance companies and households.

Issues: Health plan deductibles and other forms of cost sharing between insurance companies and households have been increasing for the last two decades. Many low-income and middle-income people either cannot afford to fund their health savings account or can only fund the health savings account by reducing contributions to their retirement accounts. The growth of out-of-pocket health care expenses has resulted in higher levels of medical debt, has caused some people to reduce savings for retirement to fund health savings accounts or flexible savings accounts and has resulted in many people foregoing necessary medical procedures and drug regimens.

Potential Solutions:

Many of the problems associated with the use of high-deductible health plans, health savings accounts and flexible savings accounts can be remedied with changes to tax rules. Proposed changes include:

Expand eligibility for contributions to health savings accounts to people with health plans that have modest deductibles and other forms of cost sharing including high coinsurance rates and high deductibles.

Replace the deductibility of contributions to health savings accounts with a tax credit to better assist low-income and middle-income households. Alternatively, provide a tax credit for contributions to health savings accounts for low-income households and deductibility of contributions for households with income greater than a specific threshold.

Modify rules governing unused funds in flexible savings accounts to allow individuals to transfer some unused fund to an Individual Retirement Account or a 401(k) plan.

Proposed changes to rules governing high-deductible plans and health savings accounts could improve health outcomes and financial security and could increase retirement savings.

Proposal Two: Modify rules governing the premium tax credit for state-exchange insurance and the employer mandate to maintain continuous health insurance coverage during job transitions and to reduce disparities in health insurance outcomes and costs.

Issues: The existence of separate employer-based and state-exchange health insurance markets causes disruptions in coverage during job transitions and disparities in health insurance costs and outcomes. Three issues need to be addressed.

Most people with employer-based insurance must find new health insurance or experience a disruption in coverage during a job transition. Loss of health coverage is always high during economic downturns.

Middle-income young adults with state-exchange health insurance pay substantially more in health insurance premiums than a similarly situated middle-income young adult with employer-based coverage.

Many people with employer-based coverage are ineligible for the premium tax credit for state exchange health insurance even if the employer-based plan is not the best plan for the household.

Proposed Solutions:

Allow employers to contribute to the purchase of state-exchange health insurance instead of purchasing employer-based health insurance.

Allow for conversion of employer-based insurance to state-exchange insurance when employees are being laid off.

Create a new tax credit covering part of the cost of state-exchange insurance for workers at small firms with income less than 400 percent of the federal poverty line.

Maintain a premium tax credit that limits workers share of premiums to 8.5 percent of income.

Modify the employer mandate to guarantee a minimum subsidy of premiums by large employers. The combination of the new tax credit and the employer subsidy will pay the entire health insurance premium for most households. Some low-income households would be eligible for additional assistance through the premium tax credit.

Proposal Three: Outlaw most short-term health insurance policies and create a new private/public low-cost health insurance option.

Issues: A 2019 Trump Administration rule expanded the use of short-term health plans which did not cover essential health benefits. Many problems are associated with the use of short-term health plans.

Short-term health insurance plans provide extremely limited coverage. Common problems include – (1) Denials of benefits for life-saving procedures (2) Strict limits on reimbursements for hospital stays, surgeries and for doctors. (3) Denial of benefits by requiring extensive documentation after a procedure has been conducted. Short-term health plans often lack coverage for pharmaceutical benefits, maternity benefits, and mental health services. People with short-term health plans can often not obtain needed health services or have large financial exposures if they become ill.

Insurance companies are allowed to deny short-term coverage to people with pre-existing conditions and to base premiums on the health status of the individual. As a result, the existence of the short-term market undermines the state-exchange markets.

Potential Solutions:

Abolish all health plans that do not provide coverage for essential health benefits as defined by the ACA.

Create a new lower-cost health plan that imposes an annual health expenditure limit.

Allow automatic enrollment in Medicaid for people with the new low-cost plan that meet the annual limit.

Limit enrollment in the new low-cost health plan to people who cannot afford current state exchange plans with no annual limits.

The combination of private insurance with an annual limit with public insurance coverage above the limit could in principle be applied to all workers. Such an approach would lower costs and provide universal coverage while maintaining private control over health decisions.

Proposal Four: Create additional regulations to limit surprise medical bills and assure that insurance companies provide adequate provider networks.

Issues: Increasingly, health insurance and employers are attempting to reduce health expenditures by limiting access to providers. Many health insurance policies impose higher deductibles and higher cost-sharing for out-of-network services. HMOS prevent consumers from ever going out-of-network. (This approach is in many ways unique to the health insurance and health care industries. In most instance, competition is increased, and prices decreased when consumers have access to many service or good providers.)

Consumers with a narrow-network health plan are most likely to experience a surprise medical bill when they are forced to go outside their network for emergency services or when they go to an in-network facility that hires out-of-network providers. A recently enacted no-surprises law attempts to reduce unexpected costs when consumers are forced to go out-of-network.

The no-surprises law does not fully address issues caused by narrow-network health plans.

The no-surprises law allows consumers to waive their rights to an in-network provider at facilities that offer both in-network and out-of-network providers. It is often difficult to obtain timely non-emergency service without hiring at least on out-of-network provider.

Health care facilities often enter and exit a network. In some part of an in-network facility could be out-of-network. (I recent found that the hospital scheduled to give a biannual heart stress test was inside the network, but the radiology department was outside the network.)

The responsibility of determining whether a network is inside or outside of the network lies on the individual consumer, not the insurance company or the provider. Sometimes information obtained from the insurance company or the provider about network status is incomplete or not up to date.

Some people with narrow-network plans often have a hard time obtaining access to specialists. This problem is most severe for extremely narrow specialties and in rural areas.

Many narrow-network plans do not offer access to top hospitals, especially cancer hospitals.

Proposed Solutions:

Create rules requiring insurance companies to provide reimbursement to all providers working at in-network facilities.

Create and enforce additional network adequacy regulations.

Require insurance companies to cover expenses for all providers working at an in-network facility.

Expand dispute resolution rules under the no-surprises act to cover all out-network situations, especially those involving use of specialists.

Create an insurance subsidy for high-cost health expenditures couple with a requirement that insurance companies provide greater access to top hospitals and specialists.

The recently enacted No-surprises law had bipartisan support. However, the approach leaves many problems associated with narrow network health plans unresolved and does not incentivize insurers to broaden their networks.

Concluding Thoughts: The 2020 health care debate in the Democratic Party involved a discussion on the merits of modifying the ACA versus the merits of replacing the existing health care system with a single-payer system. The single-payer option was both politically and economically unfeasible. The Biden-era modifications to the ACA did not result in meaningful permanent changes to health insurance or health care.

The Biden-era changes to the premium tax credit lapse in 2025. The changes in Medicaid eligibility rules, under the Covid emergency, expire in April 2023. Problems related to cost sharing and high deductibles persist and were not addressed. The issue of future loss of insurance coverage during economic downturns has not been addressed. Despite elimination of the family glitch many disparities in health care price and outcomes persist due to the separation of state-exchange and employer-based health insurance outcomes. Short-term junk health insurance problems still exist. The No-Surprises Act addressed some but not all problems associated with narrow-network health plans.

Long-term permanent solutions to health care problems can only be achieved if the Administration prioritizes health care over other concerns, including the spending in the Build Back Better Bill, some of the proposals for discharge of student loans, and even the expansion of the child tax credit. Several of the health insurance reforms discussed here deserve prioritization over other proposals because the reforms also enhance financial and retirement security.

David Bernstein is the author of the 2024 Health Care Reform Proposal, a memo that is available at Sellwireand at Kindle. This paper does a good job discussing the academic literature and providing background on the health insurance problems and policy proposals outlined in this memo. David has also written David has also written Alternatives to the Biden Student Debt Plan.

The Debt-Limit Debate and Entitlement Spending

The Republican party is linking increases in the debt limit to cuts in entitlement spending. This approach will not lead to beneficial entitlement reform. A default on the debt would lead to catastrophic economic and political impacts. The 2023 fiscal debate should concentrate on how to phase out COVID-era relief benefits, instead of entitlement reform.

Introduction:

A debt limit crisis that leads the United States to default on its financial obligations would be catastrophic. A U.S. debt default would lead to the demise of the dollar as the world’s reserve currency, increase interest rates, and reduce American influence abroad. MAGA Republicans, who supported the insurrection and are supportive of Putin’s war in Ukraine, may not be opposed to these outcomes.

GOP members of congress are threatening to refuse to support a debt-limit discharge unless the Senate and the President agree to cuts in Social Security. Go here for some Republican ideas on linking increases to the debt limit to changes in Social Security and Medicare.

The Debt Limit and Entitlements:

Many older people have very little in private retirement savings and are totally dependent on both Medicare and Social Security. Efforts to change retirement and Medicare benefits must be preceded by reforms that decrease the number of older households with low levels of retirement assets or reserves for health expenditures.

A proposal to increase the minimum age for Social Security benefits from 62 to 63 or longer would reduce the future debt to GDP ratio. Financial markets are forward looking, hence the future expected debt to GDP ratio is a more important financial variable than current-year government deficits. Entitlement reform should be more focused on the more important debt measure.

Immediate changes to entitlement spending would be detrimental to the economy, would reduce current consumption and would increase poverty among older households.

Reductions in entitlement spending cannot be implemented until after private retirement savings is increased, especially for households that currently do not save enough for retirement.

Efforts to expand private retirement savings will increase government deficits.

Restrictions on government spending and tax expenditures for pension, health and other savings incentives stemming from a stringent debt limit will delay efforts to increase private retirement savings and will delay the needed increase in the retirement age.

The debt limit is not the only lever to force changes in entitlement spending. The Trustees of the Social Security Trust fund project the trust fund will be depleted in 2035. The projected depletion of the Trust fund will, under current law, lead to the automatic benefit cuts. The avoidance of automatic benefit cuts, not the debt limit, is the best way to motivate actions on entitlement reform.

Concluding Thoughts:

Republicans do not have the votes for benefit reductions including changes in mean testing or increases in the retirement age. Immediate changes in benefit formulas would be disastrous to current retirees and worker nearing retirement. There is no support for MAGA-style entitlement reform in the Senate or in the current Administration. The Democrats can’t link any entitlement change to a temporary increase in the debt limit because such an agreement would only lead to demands for additional changes in entitlements once the debt reaches the new limit.

The 2023 fiscal discussion should center on efforts to reduce COVID-era emergency expenditures rather than efforts to force immediate changes in entitlement spending. These debates will also be difficult and could lead to a government shutdown, an admittedly undesirable outcome but one that is less catastrophic than a default on the U.S. debt.

David Bernstein, an economist living in Denver Colorado, is the author A 2023 Healthcare Reform Proposaland Alternatives to Biden Student Debt Relief Proposals.

What is going on at the lower end of the yield curve?

Why is the 6-month T-bill rate so much higher than the 4-week T-bill rate?

Many analysts are concerned about the inversion between the 2-year and 10-year bond rate because such inversions typically foretell a recession. There is a different story at the lower part of the yield curve.

The 6-month T-bill rate was 83 basis points over the 4-week T-bill rate in December 2022. The average spread over 2001 to 2022 period was 17 basis points. The median spread, 10 basis points.

The 6-month to 4-week spread had been elevated throughout 2022.

Why is the 6-month interest rate now so elevated compared to the 4-week rate?

Investors could place 1/6 of their short-term assets in separate 6-month assets purchased at the beginning of each of 6 months. This staggered schedule would allow access, if needed, to 1/6 of short-term assets each month.

The only reason why investors would choose to put all funds in a 4-week asset is the desire for increased liquidity without any price risk from selling an asset. Why are investors now turning down the 83 basis points to put more funds in a 4-week T-Bill rather than staggering investments into 6-month T-bills with purchase and maturity dates in six consecutive months?

The author, an economist in Denver Colorado, has written a 2024 Health Care Proposal, which can be downloaded at Sellwire, https://app.sellwire.net/p/2Uv and at kindle https://www.amazon.co.uk/2024-Health-Care-Reform-Proposal-ebook/dp/B09YPBT7YS