2024 Economic Issues: The Case for Expanding and Improving Individual Retirement Accounts (IRAs)

Workers without access to firm-sponsored 401(k) plans often do not save enough for retirement. Insufficient retirement savings caused by lack of access to 401(k) plans could be more effectively reduced by expanding and improving Individual Retirement accounts (IRAs) instead of expanding the use of 401(k) plans.

Introduction:   A recent GAO study found that most retirees and workers approaching retirement have limited financial resources.  Many people start their careers with substantial student debt and for a variety of reasons overspend and fail to save enough for retirement.    

Part of the disparity in retirement savings stems from lack of access to firm-sponsored 401(k) plans, which allow for much greater retirement saving than IRAs.  Part of the shortfall in retirement savings stems from the common practice of workers spending savings in retirement plans prior to retirement.  

The most effective way to reduce disparities in retirement wealth is to expand and improve Individual Retirement Accounts.  The approach outlined here differs sharply from the proposals in Secure Act 2.0, which favor expansion of 401(k) plans.  The proposed improvements to IRAs include a new tax credit, a mechanism for simultaneous contributions to traditional and Roth IRA accounts, increases in the allowable annual contribution, and alterations in rules governing distributions prior to age 59 ½.   Specific policy changes that should be implemented include:

  • A tax credit for contributions of 20 percent of contributions to an IRA.
  • Allow employers to make employer contributions to IRAs instead of a 401(K) plan.
  • A new rule allocating part of the IRA contribution to a traditional IRA and part to a Roth IRA.  (Eighty percent of employee contributions would go to the Roth account. Twenty percent of employee contributions and all employer contributions would be allocated to the traditional account.)
  • Prohibit all disbursements from the traditional account until the account holder reaches retirement age.
  • Increase the allowable annual contribution to an IRA to the current contribution limit for 401(k) plans.
  • Allow automatic contributions to IRAs and opt-out rules like the automatic enrollment and opt-out rules currently applied to 401(k) plans.

Comments:

Comment One:  The use of a tax credit instead of a tax deduction favors low-income households with lower marginal tax rates.  These household often have the most difficulty saving for retirement.

Comment Two: The new IRA contribution rules allow for the benefits of both Roth and traditional accounts.  The contribution to the Roth account reduces taxes in retirement.  The contribution to the traditional account reduces current-year taxes.  The plan described here would provide benefits comparable to benefits received from a Roth 401(k) where the employer match is allocated to a traditional 401(K) and employee contributions are allocated to the Roth component of the plan.  Many firms do not offer a 401(K) plan, do not offer a Roth 401(k), or do not match employer contributions.  The new rules would allow all workers to allocate funds to both traditional and Roth plans, regardless of what their firm offers.

Comment Three:  Current tax law allows for unlimited disbursements from retirement accounts subject to tax and penalty.  The rules governing penalty and tax on disbursements differ for traditional and Roth accounts, however, in both cases taxpayers are allowed to withdraw the entire balance of their retirement account prior to retirement.  This often happens when workers leave a job and take a disbursement rather than maintain their retirement account or roll over funds into an IRA.  The new rule requires the amount of the IRA contribution equal to the tax credit and the amount of the contribution received from the employer remain in a traditional account until age 59 ½.  Call this the George Bailey rule after the banker in A Wonderful Life who refused to close people’s accounts during a rush on the bank.

Comment Four:   Some people may be more receptive to contributing to a 401(k) plan instead of an IRA because some firms allow 401(K) owners to borrow from the plan.  Loans from IRAs are not allowed. However, contributions to a Roth IRA can be withdrawn without penalty or tax at any time.  The combination of a tax credit and early use of funds contributed to ithe Roth component of the new IRA should facilitate contributions by people with limited cash flow for emergencies.

Comment Five:  Current IRA contribution limits are substantially lower than current 401(k) contribution limits.  This proposal eliminates this disparity.  

Comment Six:  The IRS allows firms to automatically enroll employees into the firm-sponsored 401(k) plan and allow employees to opt out if they do not want to contribute.   Vanguard has found that automatic enrollment into 401(K) plans has the potential to substantially increase 401(k) participation.  Automatic enrollment into IRAs could have a similar effect, especially when combined with a new tax credit for IRA contributions and other proposed enhancements to IRAs.

Comment Seven:  Congress is currently considering the Secure Act 2.0, which would expand the use of 401() plans and create an incentive for 401(k) contributions for people who are currently prioritizing student debt repayment over retirement saving.  Even if the Secure Act 2.0 is enacted many small firms would still not offer a 401(k) plan, due to limited resources. For example, the Secure Act 2.0 would do little to increase retirement savings for people working at multiple part-time jobs.  The tax credit for IRA contributions described here would be available for all workers.  The new rules governing early distributions from IRAs would better balance the need for all workers to save for retirement while reducing debt and preparing for emergencies.

Authors Note:  David Bernstein, a retired economist has written several papers advocating for innovative centrist policy solutions.

The kindle book Defying Magnets:  Centrist Policies in a Polarized World has essays on policies student debt, retirement savings and health care.

The paper A 2024 Health Care Proposal provides solutions to health care problems that are not currently under consideration.

The proposals in Alternatives to the Biden Student Debt Plan are less expensive to taxpayers than the Biden student loan proposals.  The reforms presented here provide better incentives and reductions for future students while the Biden debt-relief proposal offers a one-time improvement for current debtors.


Ukraine and the race for the next speaker of the House

The more conservative members of the Republican House and the more liberal members of the Democratic House are adopting Putin’s position on the war in Ukraine. Can centrists of both parties unite to support Ukraine?

Initially opposition to assistance for Ukraine came from the right. 57 House Republicans opposed assistance in a May vote.  More recently, Kevin McCarthy the potential future speaker stated the House could target Ukraine funding. Former President Trump is supportive of Putin’s position on the war.

A recent letter from 29 members of the progressive caucus inside the Democratic party called on the Administration to support “vigorous diplomatic efforts” to support a negotiated cease fire and a cease fire.   Hard to understand how this approach could lead to success when Russia is bombing civilians and infrastructure, committing war crimes and controls around 20 percent of Ukraine.   

Withdrawing support from Ukraine or putting pressure on Ukraine to accept an immediate cease fire when Russia commits war crimes, has forced deportations of Ukrainian citizens, and still controls substantial Ukrainian territory, is incomprehensible to me.

The extremist Republican and extremist Democrats who basically support Putin’s position in Ukraine are a minority of the House and a minority of America.

Most pundits believe that the Republicans will have most of the next House.  They would force a reversal in U.S. policy toward Ukraine and do other detrimental things including shutting down the government and breaching the debt limit.

Speaker Pelosi has been a strong supporter of Ukrainian aid, but she is under intense pressure from her left flank on a wide variety of issue.

A centrist Democrat or Republican could run for the job of speaker.  The next speaker could be a centrist who supports Ukraine if centrist Democrats and Republicans unite.  

The Speaker of the House does not have to be a member of Congress.  The House could choose to elect a non-partisan respected figure outside of Congress to be the next speaker.

This action would result in America doing the right thing in Ukraine, could prevent future shutdown and debt-limit emergencies.  A speaker who is respected by members of both parties could facilitate the dialogue on a wide range of issues and create a process that leads to more sensible centrist policies.

Authors Note:  David Bernstein, a retired economist has written several papers advocating for innovative centrist policy solutions.

The kindle book Defying Magnets:  Centrist Policies in a Polarized World has essays on policies student debt, retirement savings and health care.

The paper A 2024 Health Care Proposal provides solutions to health care problems that are not currently under consideration.

The proposals in Alternatives to the Biden Student Debt Plan are less expensive to taxpayers than the Biden student loan proposals.  The reforms presented here provide better incentives and reductions for future students while the Biden debt-relief proposal offers a one-time improvement for current debtors.

Ukraine is the most important issue of our time.  The conflict today in Ukraine reminds me of the conflict in the 1930s in Spain against Franco and fascism.  Kevin McCarthy must not become speaker.

Should gig workers be employees?

A proposed Biden Administration rule reclassifying gig workers as employees, which intends to expand health and retirement benefits, would have adverse consequences. The proposed rule would reduce opportunities for people seeking flexible work hours, reduce employment options during economic downturns, cause some firms to reduce benefits, and worsen health insurance outcomes for some workers. Modifications to the tax treatment of individual retirement accounts and health insurance premiums would more effectively expand benefits than reclassification of work status.

Introduction:   A proposed Department of Labor rule, described here, would make it more difficult for companies to treat workers as independent contractors instead of employees. The proposal would classify workers as employees instead of independent contractors if they are economically dependent on a company. 

The purpose of the new rule is to increase health and retirement benefits for people currently employed as gig workers.   The proposed reclassification of gig workers to full-time employees does not automatically lead to better benefits for all workers and could have the unintended side-effect of decreasing opportunities in the labor force. 

  • Cost to firms maintaining current benefits packages would increase.
  • Some firms would reduce benefit packages to reduce the increase in costs stemming from the new regulation. 
  • Some firms would respond to the regulation by hiring fewer full-time employees and more part-time employees.
  • Some workers might leave the workforce because they would be unable to obtain employment offering flexible hours. 
  • Some workers with state-exchange health insurance would lose access to a premium tax credit and could receive a less generous health insurance package from their employer.

The reduction of disparities between the retirement and health benefits received by gig workers and employees could better be achieved through modifications of the tax treatment and rules governing health insurance premiums and individual retirement accounts than by the proposed regulation.  

Labor Market and Macroeconomic Issues:  

Supporters of the gig economy point out that many workers need or prefer a position that offers flexible hours.  This need is especially pronounced for people with young children.  Lack of affordable and reliable day care and was the cause of a decrease in workforce participation during the pandemic.  The forced reclassification of gig workers to employee status could reduce available flexible positions.

The existence of the gig economy may reduce loss of employment during recessions, if people who lose full-time traditional employment can find work in the gig economy.  One recent article explored the relationship between county unemployment and the proportion of county residents working online at a particular platform.  The article found that a 1.0 percent increase in county unemployment is associated with a 21.8 percent increase in the number of county residents working on-line at the platform.  This finding suggests that new regulations that reduce access to the gig work option could increase unemployment during a recession.

Health Insurance Issues:

Most working-age employees and their dependents obtain their health insurance from their employer and many employers pay a substantial portion of the health insurance premium.    Since the enactment of the Affordable Care Act, workers without an offer of employer-based insurance are eligible for a premium tax credit for health insurance on state exchanges.  The employer mandate, created under the Affordable Care Act, fined firms with more than 50 employees that did not provide health insurance to their full-time workers. 

The reclassification of gig workers as employees would reduce the role of state-exchange markets.  There is substantial disparity in the cost and quality of employer-based insurance.

In some cases, the reclassification of a gig worker to employee status will improve health insurance outcomes.  In other cases, the converted gig worker would have worse or more expensive insurance.

The reclassification of gig workers to employee status could benefit young middle-income workers with no dependents when employers pay a large share of premiums.  Many young adults receiving their health insurance on state exchanges pay 100 percent of their health insurance premium because the premium tax credit is not available when premiums are less than 8.5 percent of income.  These workers would realize lower insurance costs if they were reclassified as employees and if their new employer paid a share of the health insurance premium.

In other cases, the reclassification of gig workers to employees worsens outcomes.  Many employers offer only one health insurance plan with limited benefits, narrow networks, and high premiums for workers.  The existence of the offer of employer-based health insurance makes employees ineligible for the premium tax credit and makes state-exchange insurance unaffordable. 

A regulation leading to the reclassification of gig workers to full-time worker would cause firms that do not change their health insurance or employment policies to either increase purchase of health insurance for workers or pay a fine for full-time workers who receive their health insurance from state exchanges.  

Some firms would respond to the regulation by reducing hours worked, by increasing the number of part-time employees, thereby decreasing fines under the employee mandate.   Some firms would reduce insurance costs by increasing plan deductibles or by adopting a narrow health provider network.  Some firms would reduce the amount of their premium subsidy.

A better way to assist workers in the gig economy is to expand and improve subsidies for premiums on health insurance purchased on state exchanges while merging the markets for employer-based and state exchange insurance.  Three reforms that deserve consideration are:

  • Provide tax incentives for employer subsidies of state exchange health insurance instead of employer subsidies of firm-specific employer-based health insurance.
  • Modify the premium tax credit to provide some subsidy for young adults without an employer subsidy.
  • Create a new employer mandate consistent with the new subsidies.

The modified health insurance subsidy outlined here reduces costs of state exchange health insurance for all young adults who do not currently receive a subsidy.

The merger of state-exchange health insurance and employer-based health insurance markets and the modification of the premium tax credit will assist workers with multiple part-time jobs and will allow workers to maintain continuous health insurance coverage through periods of unemployment and job transitions. 

The merger of state-exchange and employer-based health insurance markets allows all households to search for the most suitable health insurance plan.  It prevents a situation where a worker needs specialized care perhaps at a top cancer hospital is tied to a single employer-based plan that does not offer access to the desired provider.

A more complete discussion of this health care reform proposal can be found here.   

Retirement Plan Issues:   

Many firms offer full-time employees a 401(k) plan.  Workers at firms that do not offer a 401(k) plan and gig workers must save for retirement through an Individual Retirement Account.

401(k) plans are more generous to employees than IRAs.  First, employers are allowed to directly contribute to a 401(k) plan and/or match employee contributions to the plan but are not similarly allowed to contribute to a worker’s IRA.  Second, the maximum allowable employee contribution to a 401(k) plan in 2022, ($20,500 or $27,00 if over 55 years old), is substantially higher than the maximum allowable contribution to an IRA, ($6,000 or $7,000 if over 55).

The reclassification of gig workers to employee status could lead to higher costs for firms and firms could take actions to offset the increase in costs.

Some firms will respond to reclassification of gig workers by reducing the number of workers who are eligible for participation in the firm-sponsored retirement plan.  This could occur by increasing the share of employees working part time.

Some firms could reduce employer contributions to 401(k) plans or eliminate the 401(k) plan altogether.

An alternative superior way to expand retirement benefits for gig workers is to increase the generosity of Individual Retirement Accounts and to allow firms to contribute to individual retirement accounts owned by employees and accounts owned by contractors.  Specific changes that should be implemented include.

  • Allow firms to directly contribute matching funds to Individual Retirement Accounts for employees and for independent contractors. 
  • Increase allowable worker contribution limits into Individual Retirement accounts to the level that exist for 401(k) accounts. 
  • Replace tax exemptions and deductions for Individual Retirement Account contributions with a tax credit.

The use of a tax credit for contributions to an Individual Retirement Account favors low-income workers who are in a lower marginal tax bracket.   The change from a tax deduction to a tax credit will also disproportionately benefit gig workers who tend to be in a low marginal tax bracket. 

Contributions to Health Savings Accounts are also tax deductible. Distributions from health savings accounts used for qualified health expenses are not taxed. The replacement of a tax deduction with a tax credit for contributions to health savings accounts would benefit low-income workers and could also disproportionately benefit gig workers.   Firms should also be allowed to make direct contributions to health savings accounts owned by employees and independent contractors.

The pension reforms currently being considered by Congress, discussed here, appear to increase the role of 401(k) plan and could exacerbate the gap between gig and employee pension outcomes.  Congress is not currently moving towards the pension reforms outlined in this memo.

Concluding Remarks: The typical gig worker receives less in health and retirement benefits than the typical employee.  However, the newly proposed rule that would convert gig workers to full time employees is an economically inefficient solution to this disparity.  The new rule would reduce the availability of positions with flexible work hours, reduce labor force participation among parents with young children, and could worsen unemployment during economic downturns.  The rule would result in many firms reducing health and retirement benefits.  Also, some gig workers that lose access to the premium tax credit for state exchange health insurance could be made worse off depending on the quality of the employer-based health plan received after reclassification.

A better solution to the disparity between health and retirement benefits offered to gig workers and full-time employees could be achieved through modification of rules governing health insurance premiums and rules governing Individual Retirement Accounts.

How far can ARKK sink?

The ARKK fund is down over 60 percent for the year but is still overvalued and is not a buy. Investors interested in the tech sector should consider individual holdings or a more stable ETF.

Introduction:   ETF investors often buy when the fund price declines and sell when it rises. However, a decline in the asset price does not mean the asset is correctly valued.

Even though ARKK has fallen more than 60 percent in the past year, it contains several holdings that are still overvalued, and its PE ratio is undefined because of negative overall earnings.

Empirical Analysis of Current ARKK Holdings:  The ARKK fund is an actively managed fund that invests exclusively in companies that the fund manager believes will disrupt the economy.  Data on the holdings of the fund was obtained from Zachs.  It has 34 companies and a small amount in a fund that has government securities.   Financial data on the 34 equities in the funds was obtained from CNBC.  Here is the link to financial data for Tesla the fund’s largest holding.

Financial variables for the 34 ARKK holdings indicates that despite large declines in share prices most of the holdings in the ARKK fund remain overvalued.

  • Only four of the 34 holdings (Tesla, Zoom, Nvidia, and Materialise), around 17 percent of the holdings of the fund, reported positive earnings per share.  

The weighted average of net earnings was negative making it impossible to report a PE ratio for ARKK. Firm PE ratios are undefined for firms with negative earnings. ETF PE ratios are undefined when the denominator of the PE ratio, a weighted average of earnings per share is negative.  

An alternative valuation metric used when earnings are negative is the difference between share price and earnings per share price over share price.  High values of (P-E)/p correspond to high valuation measures.  

A value of (P-E)/P equal to 0.98 is equivalent to a PE ratio of 50.  A value of (P-E)/P greater than 1.0 is undefined due to negative earnings.  The use of (P-E)/P allows for the inclusion of firms with negative earnings in comparisons of portfolio valuations. Go here for a discussion of the alternative valuation statistic.

  • The value of (P-E)/P for ARKK is 1.082.

High valuation measures are acceptable when firms are investing and growing.  Early investors in firms like Apple and Amazon did quite well despite years of high valuations.  The ARKK holdings are not similarly situated.

  • 33 of the 34 ARKK stocks experienced a decline in price over the past 52 weeks.  The average stock price over the last 52 weeks was down 63.1 percent.   The lower stock price makes it expensive for these firms to raise additional funds in equity markets. 
  • 9 of the 34 companies had an earnings per share loss that exceeded 25 percent of the stock price.   The existence of larger losses relative to share price could be indicative of concerns about future liquidity. 
  • ARKK owns more than 5.0 percent of the shares in 16 of its holdings.   These relatively high stakes could limit the ability of ARRK to reallocate and reduce exposure without exacerbating declines in stock prices. 

The empirical analysis reveals several red lights on the future of ARKK including — high valuations, previous large stock price declines, existence of several holding with large losses compared to equity, and high exposure in some positions.

Discussion of ARKK holdings:  The rationale behind investing in potential disruptors is the likelihood of one or more large successes leading to large returns.  Some of the ARKK investments are interesting and could be considered once the tech market nears a bottom.  However, ARKK has a lot of companies that are unlikely to prosper.

I looked at some of the news and analyst on the 10 largest ARKK holdings.  Here is what I found. 

Tesla: symbol TSLA Tesla is the largest position and ARKK’s most successful investment.  Tesla has been a true disruptor.  However, its valuation is high $642.3 billion more than the rest of the world’s auto industry.  Tesla sold fewer than a million vehicles in 2021 compared to over 9 million by Toyota alone.  Tesla makes most of its money from the sale of cars but does have some other energy streams.  Tesla is the leader in electric vehicles, but Porsche may have the better high-end car and other firms are entering.  At current stock prices Tesla is a better buy than ARKK but may not be a good long term buy.  Even with other income streams it is difficult to justify a price on Tesla that makes a relatively small auto company more valuable than the rest of the industry. I am not currently a buyer of either the TSLA or ARKK.

Zoom: symbol ZM, Zoom did extremely well due to at-home work during the pandemic, but the pandemic growth rate is over, and the company is facing new competition from Microsoft and possibly other larger firms.

Roku: symbol ROKU, Roku attempts to make it easier and more affordable for people to watch multiple TV shows.  ROKU’s top competitors are Apple, Net Flix, Amazon, and Microsoft.  Stock price is falling.  If you google ROKU and problems, you get several links on how to deal with technical ROKU issues.  Other applications and services may be more reliable than ROKU.   I have no reason to believe that ROKU will win this competition.

Unity:  Unity Software, symbol U. is a software developer and may benefit from the metaverse.  The company might be acquired by a larger firm.  A speculator might be better off purchasing a small amount of U rather than ARKK.

Block inc., symbol SQ, is a financial services firm.  Visa and Paypal appear to be better positioned than Square.

Teledoc, symbol TDOC, has several active competitors.   Go here for one list.  Two funds owned by Cathie Wood have invested in Teledoc.  She may not be able to get out of these positions without causing a large decline.  I would not buy Teledoc either by itself of through ARKK.

UI Path, symbol Path, is an artificial intelligence company that helps automate routine tasks.  It has viable products but it stock price has fallen by nearly 80 percent.  Path is a company that might be worth looking at once the tech sector bottoms.  ARKK bought it too soon.

CRISPR, symbol CRSP and BEAM therapeutic, symbol Beam: are two gene editing companies owned by ARKK.  Combined they are around 8.5 percent of ARKK holdings.  Hard to understand why ARKK holds so much of these two firms and no Moderna.

Coinbase, Symbol COIN:  Coinbase is a bad apple in an industry that is looking for a reason to exist.  Google Coinbase and allegations and get this.

Some of the ARKK holdings deserve consideration, but ARKK is not the best way to participate in these opportunities.  Interested investors should consider purchasing the better companies directly or investing in a more diversified tech fund, like VGT.

 Concluding Remarks:

I have nothing against a fund that seeks out disruptive firms but believe ARKK is poorly designed and not an appropriate investment vehicle.

The ARKK fund did well when expectations of tech returns were high and interest rates were abnormally low. It is wrong to attribute the sinking of ARKK over the past year to higher interest rates since rates today are still below their historic medians.

The investment philosophy behind ARKK is reminiscent of the gamblers ruin problem.  The gambler playing a game, or in this case several highly correlated games, with a negative expected value will eventually go broke.  

The disruptor fund might put 50 percent in a small number of disruptors and 50 percent in a safe asset.  The fund would take profits and invest in the safe asset in successful years and invest in bargains during downturns.

Authors Note:  David Bernstein has written Financial Decisions for a Secure and Happy Life, a manifesto that will improve your life and save you tens if not hundreds of thousands of dollars.

Should the Fed Pivot?

Short Answer is no. Interest rates have been artificially low for 15 years and remain below historical averages. The long era of artificially low interest rates created a bubble that was unsustainable. It is this bubble leading to a financial collapse, not Fed tightening, that will lead to an economic downturn.

Some perspective:

The Federal Reserve Board is supposed to be above political pressure.  That tradition along with several others died in the Trump era.  Remember when Trump was actively considering firing Powell.  More recently, it was Senator Warren that argues that Powell wants to throw Americans out of work even though the unemployment rate remains at 3.5 percent.

The other source of political pressure is from market participants, both participants in bond and equity markets who are used to low interest rates.   The taper tantrum of 2013 occurred when the fed announced it was going to gradually reduce asset purchases. Today the pressure is on the Fed to pivot and halt increasing rates.  Famous Fund manager Cathie Woods now writes that Fed tightening can lead to a deflationary post.  

Recession is possible but deflation is not a credible concern.  Substantial inflation now exists and will not go away soon. The economy would be much better off now if Powell had ignored Trump’s threats in 2018 and had recognized that inflation in 2022 was not transitory. 

The primary cause of the coming recession is not Fed tightening.  It is instead the collapse of a stock bubble that was the result of excessive monetary growth.    This bubble and collapse could have been prevented if the Fed had previously ignored Wall Street whims.

Analysis:  Interest rates are not high compared to past figures, especially given the level of inflation.  

The first set of figures for the 1-year and 10-year constant maturity bond rate and inflation cover the 1953 to 2022 period.

  • The current October 2022 one-year constant maturity rate is 8 basis points below the 1953 to 2022 median.
  • The current October 10-year constant maturity rate is 106 basis points below the 1953 to 2022 median.
  • The current inflation rate is 583 basis points above the 1953 to 2022 median.

The fact that the interest rates are low compared to historical figures when inflation is high is remarkable because borrowers generally require an interest rate that compensates them for inflation.

The second set of figures involves comparisons of current rates to the 1971 to 2023 median.  The shorter more inflationary period allows for inclusion of the 30-year mortgage rate.

  • The current rate is 356 basis points lower than the median for the 1-year bond, 469 basis points lower for the 10-year bond, and 315 basis points lower for the 30-year fixed rate mortgage, even though the current inflation rate is 287 basis points above the median.

Interest rates did rise quickly in 2022 primarily because rates were at such an artificially low level.  I compared actual September 2022 interest rates to predicted interest rates generated by a simple distributed lag model.   

  • The one-year interest rate rose a bit more than expected by the model.  The actual one-year rate was 3.9.  The predicted rate was 2.9.
  • The actual 10-year bond rate of 3.52 percent was very close to the predicted rate of 3.45 percent.

Concluding Remarks:  Interest rates are still below their historical medians.  When I look at likely interest rate outcome based on inflation and future inflation expectations, I see greater likelihood of higher inflation leading to higher interest rates and capital losses on bonds than interest rate declines and gains in bond prices.  

A Federal Reserve Policy pivot would increase my concern about higher inflation and interest rates.

I am not optimistic that the Fed Policy will lead to a soft landing, because inflation over the next few years may be driven by wages and low labor force participation, which could best be addressed by a more lenient immigration policy and tax incentives encouraging work.  

Authors Note: 

David Bernstein is the author of two recent policy memos.  One memo examines alternatives to the Biden Student Debt Plan. The memo argues that Biden’s student debt forgiveness plan and expansion of Income Based Replacement Loans will prove ineffective.  Several alternative policies including elimination of debt for first-year students, policies that promote on-time graduation, and interest rate concessions coupled with more stringent collection efforts on older loans near maturity are proposed and analyzed.

Another memo, A 2024 Health Care Reform Proposal , considers substantive health insurance reform.  The policies proposed here include ideas to provide continuous health insurance coverage during job transitions, improvements to health savings accounts, the elimination of short-term health plans, and a proposal to address problems caused by narrow-network health plans.

David Bernstein is also the author of eight personal finance memos contained in Financial Decisions for a Secure and Happy Life.  The book provides guidance on a number of topics including the choice between saving for retirement and reducing student debt, the choice between traditional and Roth retirement accounts, ways to minimize loss of retirement income from high-fee 401(k) plans and the advantages of the use of Series I Savings Bonds.  This $7.00 40-page memo could save you tens, even hundreds of thousands of dollars over a lifetime.

How to Insulate Your Portfolio from Inflation

Annual limits on the purchase of Series I is more than $10,000 if you have a tax refund or some other entity like a Trust or business. Additional inflation protection can be obtained through the purchase of Treasury Inflation Protection Securities (TIPS).

Question: I am worried that my retirement plan will not keep up with inflation and would like to increase my holdings of Series I savings bonds.  However, there is a $10,000 annual limit on purchase of these assets. What can I do?

Answer:   The purchase of Series I savings bonds is the single best way to protect yourself and your household against inflation. Series I Bonds are literally the only thing working in most portfolios today, a situation that will unfortunately persist unless inflation drastically recedes.

The Treasury limits direct purchases of Series I Bonds from Treasury Direct to $10,000.  However, taxpayers with a tax refund can purchase an additional $5,000 in Series I Bonds. Go here for a discussion of how to do this.   You can also purchase Series I bonds through a Trust or a business.   The first step is to go to Treasury Direct and set up an entity account.

The annual limits prevent most households from quickly increasing their holdings of Series I bonds in response to a sudden shift in inflationary expectations.

Additional protection against inflation can be obtained by purchasing Treasury Inflation Protection Securities (TIPs). There is $10 million dollar limit on each TIPS security for each auction.  I am not worried about every being constrained by this limit.

The price of TIPS varies with interest rates and inflationary expectations, and you can lose money on TIPS. But price risk can be managed by staggering the purchase dates and maturity dates of the TIPS bonds and holding the bonds until maturity.

Series I Bonds are sold at par and never fall in value.    The semi-annual rate can go up and down with inflation, however, the bonds will not fall in value with inflation.  Go here for Series I FAQs from Treasury Direct.  Go here for a comparison of Series Bonds and TIPS.Authors Note:  The paper Financial Decisions for a Secure and Happy Life  is a collection of eight essays.  One of the essays provides a lot of information on Series I bonds and Tips.  The author has also written extensively on health care with his most recent paper outlining potential 2024 care reform proposals

The Likelihood of Higher Future Interest Rates

Despite recent tightening by the Federal Reserve Board, interest rates remain relatively low both compared to past decades and the current inflation rate. Persistent Inflation will lead to a long period of higher interest rates.


Introduction:

Some pundits believe inflation has peaked, and it is now time to buy bonds. These pundits offer an inaccurate macroeconomic assessment and bad financial advice.

Comment One:  The nominal 10-year Treasury interest rate is roughly where it was in February 2014, but inflation is substantially higher. 

Both in February 2014 and September 2022, the 10-year constant maturity interest rate was 3.4 percent.

  • In February of 2014, the one-year inflation rate was 1.6 percent. It had hovered close to that level for the entire year.
  • The reported inflation rate in August of 2022 was 8.2 percent up from 5.2 percent, 12 months early. 

People purchasing 10-year bonds are now earning far less than inflation.   We should expect this gap to narrow and bond yields to rise unless inflation suddenly plummets.

Comment Two:   Interest rate comparisons based over data from the last 10 or 15 years are deceptive because rates have been abnormally low.

Comparisons to average and high interest rates over a longer period are more relevant.

  • This graph shows the 10-year rate reached 5.0 percent in June 1967 and stayed above 5.0 percent until July 1998, literally 31 years.  The current 10-year rate is 3.5 percent.
  • This graph reveals that while the current two-year constant maturity rate is at its highest level since 2007, it is also lower than any rate that existed between 1976 and August of 2001.

Comment Three: The reduction in interest rates requires a decrease in inflation, an unlikely outcome in the near term. 

In a previous era, the Federal Reserve used two tools, higher interest rates and lower money supply, to reduce inflation.  Today the main tool is higher interest rates, which remain below historic levels.   

The money supply has grown robustly during the pandemic and is at a high level compared to the size of the economy.  The impact of past increases in the money supply on the price level has not been fully realized.  Whether the Federal Reserve Board can reduce the inflation rate without reducing the money supply is questionable.

Comment Four:  Wages are likely to continue to increase, even if there is a recession, leading to 

significant wage-push inflation over the next few years.  

There are many reasons why worker compensation is likely to continue to increase over the next few years.

  • One way to reduce the gap between job openings and people, noted here, is to increase immigration, an outcome that appears unlikely in the current political environment.
  • Many workers are burnt out from COVID and resistance to returning to the office can increase wages in some areas, especially for firms and industries dependent on in-person work.  
  • There is a shortage of teachers, nurses, airline pilots, long-haul drivers, and highly skilled computer analysts. These shortages won’t be instantly reversed with the advent of a recession.  The shortage of nurses guarantees that health care costs, a key component of both the CPI and workers compensation will not fall in the near or intermediate term.   
  • Some unions have recent won large increases in compensation, with a recent example being the rail unions.  Increases in rail transport prices will increase the price of transported goods.

The wage-push inflation will make it very difficult to reduce inflation and return to the abnormally low interest-rate environment.

Comment Five:  The housing component of the CPI will not fall with an increase in interest rates.

The housing price component of the CPI described here is based on imputed rents.  An increase in mortgage interest rates generally leads to higher observed and imputed rents.

The increase in interest rates will reduce the affordability of new mortgages and decrease house prices. However, relatively few households buy or sell a house in a particular year.   Increases in interest rates, which delay home purchases, can increase both actual rents and imputed rents used for the CPI housing cost calculation.

Increases in the housing cost component of the CPI, stemming from higher interest rates, will contribute to inflation despite a decrease in aggregate demand from higher interest rates.

Comment Six:  More supply shocks leading to more inflation are likely.

The most likely supply shock from the Ukraine war involves higher food prices from disruptions in grain and fertilizer exports.

Concluding Remarks:   How should investors respond to this economic outlook?

Avoid long-term bonds, anything with a maturity more than two years.

Avoid bond ETFs.  Even shorter maturity ETFs and ETFS that own TIPS bonds have been problematic over the last year.

Purchase at least $10,000 in Series I Bonds every year from Treasury Direct.  Additional purchases beyond the $10,000 limit are possible through tax refunds, trusts and S-corporations.  For details go to essay five here.

Allocate a small share of your wealth to two-year Treasury bonds.  The purchase and maturity dates of the bonds should be staggered to create constant liquidity when the bonds mature.  Ownership of bonds is preferrable to investments in bond ETFs because bonds return the initial investment at par value on the maturity date.

Authors Note:  David Bernstein is the author of eight essays published in Financial Decisions for a Secure and Happy Life. 

The Case for Rapid Repayment of Student Debt

New entrants to the workforce need to prioritize student debt reduction over contributions to 401(k) plans.

The first of eight essays in my new paper Financial Decisions for a Secure and Happy Life makes the case that new entrants to the workforce must often delay savings for retirement to quickly eliminate most if not all their student debt.  There are several reasons for this finding.

Reason One:  Failure to reduce student debt to a manageable debt level often leads to poor credit and higher borrowing costs on auto loans, credit cards, private student loans, and mortgages.

Reason Two:  A person using a short maturity loan will pay substantially less in interest than a person using a long maturity loan.

Reason Three:  The decision to enroll in an Income Driven Repayment loan and only pay the minimum balance will often result in increased loan balances and substantially higher lifetime interest payments. 

Reason Four:  The quick reduction of student debt frees up cash for other financial priorities including increased savings for retirement.

Reason Five:  Most young student borrowers choosing to immediately save for retirement on their first job will raid their 401(k) plan and pay tax and penalty.

Reason Six:  The rapid elimination of student debt facilitates the purchase of a first home, lower mortgage costs, and higher house equity, an important source of wealth. 

The succinctly written eight essays in  Financial Decisions for a Secure and Happy Life can be obtained for $7.00.  I suspect you will find the financial strategies and tips outlined there worth much more.

The Opening Salvo of the 2024 Health Care Reform Debate

The paper “A 2024 Health Care Reform Proposal” is available free for a limited number of potential reviewers.  Just go to this link https://app.sellwire.net/p/2Uv

and apply promotion coder REVIEWER1.

Ideas in this paper could reduce number of people without health insurance and improve the quality of coverage.

Proposals Include:

  • Having employers subsidize state exchange health insurance instead of paying for firm-specific health insurance to reduce loss of insurance during periods of unemployment and job transitions.
  • Further modifications to the premium tax credit to reduce worker share of premiums for middle-income young adults without employer-based coverage.
  • Creation of new low-cost comprehensive health insurance plans combined with the elimination of current short-term health insurance plans.
  • Improvements in Health Savings Account for low-income and mid-income households. 
  • Creation of incentives leading to Increased access to top hospitals and specialists.

Again, purchase at a low price of $2.50 or download a free sample copy here.

https://app.sellwire.net/p/2Uv

I hope if you take the free sample, you will provide me with feedback either in the form of an email to Bernstein.book1958@gmail.com or through an on-line review.

Analysis of the Abraham and Strain Student Debt Argument

A recent article authored by Abraham and Strain arguing against a debt relief proposal under consideration by the Biden Administration was inaccurate. The proposal under consideration mostly benefits middle-income borrowers and the program could be means tested. Existing IDR programs have proven to be ineffective. Bankruptcy reform won’t pass Congress. Student debt discharge is the only realistic way to stop the increase in student debt burdens and reduce the number of people foregoing higher education.

Introduction:

Abraham and Strain claim a debt relief proposal for student borrowers considered by President Biden is regressive.  They cite research indicating that a blanket forgiveness of $10,000 in student debt relief would offer $3.60 in debt relief to households with the highest 10 percent of income compared to $1.00 for the bottom 10 percent.  The research they cite also found that ¾ of the benefit from the proposal under consideration would flow to households with income over the median.  They argue that expansion of Income Driven Replacement (IDR) loan programs and alteration in the treatment of student debt in bankruptcy would be a more effective way to assist students with excessive student loans.

Comments on arguments advanced by Abraham and Strain:

I am not surprised that student debt does not provide much benefit to households with income in the bottom ten percent because education is the best way to avoid poverty. Most of the advantages of the current student loan discharge proposal appear to go to middle income people with income between the 25th and 75thpercentile.  The percent of people receiving benefits in the middle of the income distribution is a much more interesting portrayal of the equity of the proposal than the percent of benefits going to people with income over the median. 

IDR programs have proven to be ineffective at providing debt relief to student borrowers, especially middle-income borrowers.  The Public Service Loan Forgiveness loans, which are tied to IDR loans were not discharged in a timely fashion and it is likely that borrowers in long-term IDR programs will experience a similar fate.  People in IDR loan programs often can’t qualify for a home mortgage because of uncertainty about their income and loan payment. The relative merits of an IDR versus a conventional loan are unknowable immediately after the student borrower finishes school and starts repayment.  IDR loans can be negatively amortized, and many IDR borrowers pay substantially more on their loan than if they took out a conventional loan.

Abraham and Strain argue for allowing the discharge of student loans in bankruptcy, an action that would not pass Congress.  Alternatively, it would be useful to modify chapter 13 bankruptcy payment rules to allow for increased student debt payments and decreased payments on other consumer loans during the chapter 13 bankruptcy period.  This proposal also probably lacks the 60 votes needed to get through the Senate. 

Abraham and Strain argue that it is inappropriate to treat student borrowers from people who borrowed for other purposes.  However, this is exactly what current bankruptcy law does and Congress is not going to change this situation.  A second-best answer is to provide debt relief.

The $10,000 immediate student loan debt discharge strikes me as excessively generous.  I agree that it could encourage increased future borrowing.  I would structure debt relief at the greater of 20 percent of outstanding loans per year or $3,000 per borrower per year for five years.  I would exclude borrowers with household income greater than the 90th percentile.

Concluding Remark: 

These has been a constant increase in the trend growth of the number of entrants to the workforce with student debt, the average student debt burden for new workers, and the number of older workers leaving the workforce and entering retirement with unpaid student loans. 

I understand that most people with student debt are better off than people who never went to college but increases in the burden of going to college will almost certainly increase the number of people foregoing higher education.  Congress is not going to act on this problem.  Many of the proposed solutions won’t work.  Some unilateral debt relief is the only way to avoid worsening debt burdens and increases in the number of people foregoing higher education.

David Bernstein, an economist living in Denver Colorado is the author of A 2024 Health Care Reform Proposal.  Use promotion code REFORM101 for a discount on the paper.