Economics of Retirement

This is a repost from Forbes.

Standard indicators point to a coming downturn. However, a new indicator – racial unemployment rate gaps – may also help understand the recession in our near future.

After 11 years of economic expansion, the difference in the unemployment rates between black and white older workers is at historic lows – just 1.1 percentage points apart (details below). This may seem like good news, since black workers usually suffer from higher rates of unemployment than whites. And, while it is indeed good news for racial equity, it is likely temporary. Based on historical patterns, which often best predict the future, not only will racial gaps get worse in the next recession, the next recession will be soon.

Racial jobless gaps are widest at the depth of recessions and narrowest at the peak, right before the economy goes into recession. Now, we see the narrowest differences in joblessness rates by race since the last peak. This indicator MAY be pointing TOWARD a recession.

Of course, predicting the precise time of the next recession is not possible, but the consensus among economists is that we are due: the 11-year economic expansion is one of the longest in U.S. history.

The St. Louis Fed provides a helpful list of the standard leading indicators of a recession:

1. “A big increase in oil prices has preceded nearly every U.S. recession since World War II.”

President Trump tweeted on April 20, “Oil prices are artificially very high! No good and will not be accepted,” as if President Trump could stop the price rise and stop the recession. Brent crude prices increased to $74.62 on April 24th, climbing over 50% in the last year. Increases in gas prices have erased the expected income boost of the tax cut for most families below the median.

This indicator is pointing TOWARD a recession.

2. “Asset prices swelled before the two most recent recessions: stock prices before the dot-com bust in 2000 and housing prices before the financial crisis.”

The Economist’s lead story six months ago was “The Bull Market In Everything.” In April, the Shiller price-earnings ratio measure for the U.S. stock market was about 31. For reference, the PE ratio was about 27 in October 2007 and 44 in December 1999.

This indicator MAY be pointing TOWARD a recession.

3. Inverted interest rates, or when interest on a short-term debt (say, three-month Treasuries) is higher than interest on a long-term debt (say, 10-year Treasuries).

An inverted yield curve, or inversion, has preceeded all recessions since 1960. Long-term interest rates are becoming less “inverty,” which could be good or bad news. It's good news if investors are willing to pay more for long-term debt because expectations about growth and profits are high – what economists say is a “real” economic phenomenon, or because wages and oil prices will drive inflation.

This indicator is pointing AWAY from a recession.

I wish I could tell the over 15 million older workers in the U.S. when the recession will hit so that the half of them with significant retirement assets can time the market and protect their nest egg. But really, the best advice comes from 12-step programs – know what you can control and what you can’t. Ignore all feelings of panic and temptation to control asset prices with market timing – like ignore this essay about the next recession. And keep your wealth diversified: 40-ish percent in stock, 40-ish percent in cash and bonds, and 20 percent-ish in home equity, which is part equity and part consumption (you gotta live somewhere).

As promised, I’d like to share more details supporting my speculation. With my team at the Schwartz Center for Economic Policy Analysis (SCEPA) in the The New School’s economics department, we found that the black/white unemployment gap might become a predictor of downturns.

In the aftermath of the recession in 2003, the black unemployment rate for older workers was 6.8%, 2.9 percentage points greater than the older white unemployment rate of 3.9%. By the time that expansion peaked in December 2007, signaling the start of the Great Recession, unemployment rates dropped to 4.2% for black older workers and 3.3% for white older workers, narrowing the racial jobs gap to 0.9 percentage points. When unemployment increased again in 2011, black older workers’ unemployment rate grew to 10.1%, 3.6 percentage points higher than white older workers at 6.5% - the largest gap in the past 15 years. As of February 2018, almost 11 years since the last round of low unemployment rates, the racial unemployment gap has once again narrowed to a gap of just 1.1 percentage points.

Economic growth shrinks the racial gap in unemployment for a number of reasons. When workers are scarce, employers relax hiring practices that have discriminatory effects. In recessions, the racial unemployment rate gap grows because older black workers lose their jobs faster than older white workers.

This is a repost from Forbes.

The need to solve the retirement crisis is defying today’s political divisiveness by giving us a rare example of bipartisanship. In the last month, four experts of varying political stripes called for creation of mandatory retirement savings accounts to replace our failed “do-it-yourself” voluntary system. This includes economist Teresa Ghilarducci (an author here) and Rescuing Retirement co-author Tony James, president of private equity firm Blackstone; Jason Fichtner, a former Bush administration economist; and Third Way, a centrist Democratic think tank.

And while there are significant disagreements in the details, it is nothing less than a sign of the growing political will to take bold action to ensure our workers can retire and our retirees stay out of poverty.

Unfortunately, the shared call for mandatory retirement accounts neglects the foundation of retirement security, Social Security. The protection and expansionion of this program is a necessary starting point for securing and building retirement security. To be clear, we believe that bold proposals for individual retirement accounts – as necessary as they are – simply will not work without first strengthening Social Security.

Polls of the American public persistently report two results. First, that Social Security is highly popular, considered efficient and effective. And second, that over half of Americans don’t think they will have enough money in retirement. On both, the public is spot on. Without reform to bridge the gap between Social Security and private savings, when they reach age 65, 30 percent, or 21 million Americans ages 50-60, will be poor or near poor as retirees.

As economists, we believe it’s possible to fund both an expansion of Social Security and mandatory individual retirement accounts on top of Social Security.

To ensure all workers a secure retirement and the end of elderly poverty would require an additional $500 billion in retirement contributions from workers, employers, and the government. While less than 3 percent of GDP, $500 billion is not trivial. Rather, it is similar in magnitude to the 10-year cost of $5.5 trillion to fund the recent GOP tax cut.

How does this work? First, every worker would pay an additional 5.8 percent of pay towards their retirement security, or about 80 cents per hour. This breaks down into three parts.

First, 2.78 percent to secure Social Security (one way among many to provide needed revenue). This would ensure workers receive their full and promised Social Security benefits and provide retirees with an average of 36 percent of their pre-retirement income.

Second, an additional 0.02 percent would raise the special minimum benefit to bring almost every elder above the poverty line. The special minimum benefit places a floor under the benefits of lifetime low earners, but has eroded over time and now almost no new claimants qualify.

Third, 3 percent to fund mandatory individual savings accounts for retirement. Alone, this contribution is unlikely to permit all workers to maintain their living standards in retirement. However, it is designed to add on to retirees’ monthly Social Security benefit to ensure they can live well clear of poverty or near poverty. We could follow the lead of Australia’s mandatory retirement savings program, which started with a 3 percent required contribution and is now up to 12 percent. The program will also allow for those who want to contribute more to do so.

Accumulating retirement savings is just the beginning. How the money is invested matters, as does how savings are paid out to retirees as well as how retirement tax breaks are distributed to low-, middle-, and high-income workers. The Ghilarducci/James proposal for Guaranteed Retirement Accounts (GRAs) calls for pooled investments to ensure workers earn the highest risk-adjusted returns possible, guaranteed principal to make sure workers’ contributions aren’t eroded by market risk, and annuity pay-outs to ensure retirees don’t outlive their savings. And lastly, the GRA includes an inflation-adjusted flat tax credit to incentive savings and ensure contributions are cost-neutral for those with low incomes.

Bottom line: If young workers and their employers, with assistance from a government refundable tax credit, paid 5.8 percent more – 2.78 percent in Social Security, 0.02 percent for poverty alleviation, and 3 percent in an well-managed and invested retirement account - they would be secured from poverty and near poverty in retirement. Workers approaching retirement without adequate savings would have to increase their savings by considerably more that 3 percent. But these workers would be better off than they are today, with universal access to a low-cost savings retirement program. And the lesson of Australia is that the sooner the program starts, the sooner it matures.

This post was written with ReLab Research Director Anthony Webb and SCEPA Associate Director Bridget Fisher.

This is a repost from Forbes.

Here is the best financial lesson I can offer: there are two sides to the interest rate – the getting side and the paying side. You want to be on the getting side.

How do you do this? Pay off your mortgage as soon as you can, and definitely pay it off before you retire. And don’t buy a home if you can’t afford to pay it off between five to 10 years.

Unfortunately, that’s not the norm. Thanks to the commonplace position of the 30-year mortgage, it is more popular despite the lower costs of shorter-term loans. The 30-year mortgage was originated during the Great Depression to help borrowers lower their monthly payments and avoid foreclosure. But now, Americans are more indebted to banks for mortgages than homeowners in other advanced market economies. In exchange, those paying longer obligate themselves to pay more than double over the lifetime of the debt.

On the other hand, the 30-year mortgage is very friendly to real estate brokers, home developers, and banks. Simply put, it allows them to sell more expensive houses. Bankers are gleeful to hand out mortgages that more than double their interest revenue.

Here’s an example of how the math works. In April 2018, a 30-year mortgage charges about 4.18% in interest, whereas a 15-year mortgage charges about 3.75%. If you borrow $100,000 for half the time, your total interest paid doesn’t just decrease by half. It falls from $75,626 to $30,900, or by 60%.

But why pay the bank $30,900 at all? Put it in your retirement account. This way, you earn the interest.

Here are answers to the objections I usually hear when I advise people to pay off their mortgage.

1. “The government lets me deduct the interest.”
Answer: If you are a high earner and pay an income tax rate of 39%, you pay the bank $1 and the government reduces your taxes by 39 cents. But the bank still gets your 61 cents! Do you like banks better than your favorite charity or yourself? And, as you get closer to paying off your loan, a larger share of each monthly mortgage payment goes to principal rather than interest. This decreases the amount deducted from taxes, making the deduction worth less.

2. “I want to use cheap mortgage money to make more money.”
Answer: Sure, businesses pay interest and leverage hoping to invest in ventures that pay a higher rate than the interest rate. That’s the plan – and the hope. Most businesses fail because hope doesn’t come through -the debt overwhelms them. Individual households have even less means or scope to handle leveraged risk.

3. “My house will appreciate more than the interest rate, especially after the tax deduction.”
Answer: Maybe, but you could also be paying tens of thousands to the bank and be underwater. Average house appreciation rates vary wildly, and a financial crisis can happen at any time, perhaps when you reach your 60s.

4. “If I use all my money to pay off my mortgage, I won’t have any money for emergencies and I will be cash-poor and house-rich.”
Answer: Don’t be cash poor. Have six months of salary in cash for emergencies. Max out on your retirement savings and pay off your mortgage. Paying off a 4% mortgage (even with a tax deduction of the average 28%) is like earning a risk-free rate of 2.88% (4% - 0.28% of 4% = 2. 88%). There aren’t many places on the planet where you can earn 2.88% risk free. No longer paying interest on your loan, paying it off can be like earning the equivalent risk-free return.

5. “I don’t want to store all my wealth in my house.”

Answer: Diversifying assets is always best practice. However, most families’ greatest asset is Social Security and Medicare (worth about $400,000 for an average couple), followed by home equity of about $110,000, and their retirement account with about $30,000 in stocks and bonds. Having a large chunk of your money tied up in your home might seem unwise, but not when you consider that you are also using the house for a necessary consumption. You need to live somewhere, and you can’t live in a stock or bond. Also, if your house appreciates in value, you can sell it or refinance. But if you don’t pay off your mortgage, you won’t have the equity.

6. “I haven’t contributed the maximum amount to my 401(k), IRA or other retirement accounts.”
Answer: I often hear this as a reason why people slow down their efforts to pay off their mortgage. While paying into your retirement account is a better use of your cash than paying off your mortgage, ideally you want to max out your retirement savings and accelerate your mortgage payments.

But retirement security is a big topic and anyone trying to secure their retirement needs more tactics than paying off their mortgage. Some tactics include changing spending plans and saving in retirement accounts and others include a more comprehensive national policy solution. For instance, everyone needs a retirement savings plan and to contribute to it from the beginning of their career. I have two small and easy-to-read books on how to have enough in retirement and how to change federal policy so we can rescue retirement with a Guaranteed Retirement Account.

[Pro-Tip: A good way to reduce interest payments is to make extra payments to pay off the principal. Decreasing your balance decreases your interest paid.]

7. “I have high interest credit card debt.”
Answer: Using cash to pay off high-fee credit card balances is another good reason to temporarily keep some mortgage balance. You want to use your cash to pay off high-interest loans. Paying the monthly minimum of $110 on a credit card balance of $5,000 with 15.99% interest rate will take 25 years to pay off. And the $5,000 will balloon to $12,000. Its even worse if you continue to use the card, adding more debt.

[Pro-Tip: Tear up your credit card, then pay off the balance as soon as possible. Do keep one – you can’t rent a car without one – but use it like cash and record every card expenditure in your checking account log.

Let’s be positive. Here are the reasons to pay off your mortgage:

1. Good retirement planning is about accumulating assets AND reducing spending. You will have less income in retirement, so eliminating your monthly mortgage can greatly increase the amount of money you can spend on fun activities and medical expenses that will surely increase. Ideally, you followed the advice in the first paragraph and didn’t buy a home with a mortgage longer than ten years.

2. Paying off your mortgage early transfers the money you would have paid the bank to your pocket.
It almost always makes sense to pay off your mortgage before you retire, but use a mortgage payoff calculator to convince yourself that it’s better to pay off your debts before retirement because new costs – like medical costs will soar.

The Bureau of Labor Statistics (BLS) today reported a 3.2% unemployment rate for workers age 55 and older in March, a rate unchanged since February.

For decades, economists have documented that the racial gap in unemployment rates is widest at the depth of a recession and narrowest right before the economy goes into recession. In short, that black workers are the first fired and last hired over the business cycle.

Older workers are no exception. We are now 9 years into an economic expansion - one of the longest ever - and the racial jobs gap for older workers is at record lows. However, we predict that when the downturn begins and unemployment increases, older black workers will be disproportionately laid off and, once again, experience higher rates of unemployment. 

In 2003, the aftermath of the recession, the black unemployment rate for older workers was 6.8%, 2.9 percentage points greater than the older white unemployment rate of 3.9%. By the time that expansion peaked in December 2007, signaling the start of the Great Recession, unemployment rates dropped to 4.2% for black older workers and 3.3% for white older workers, narrowing the racial jobs gap to 0.9 percentage points. When unemployment peaked again in 2011, black older workers’ unemployment rate grew to 10.1%, 3.6 percentage points higher than white older workers at 6.5% - the largest gap in the past 15 years. As of February 2018, almost 11 years since the last round of low unemployment rates, the racial unemployment gap has once again narrowed to a gap of just 1.1 percentage point.

Following this trend, when the economy takes another downturn, black older workers will most likely face more risk of losing their jobs and/or not finding new jobs at a higher rate than older white workers.

Economic growth shrinks the racial gap in unemployment for a number of reasons. When workers are scarce, employers relax hiring practices that have discriminatory effects. In recessions, the racial unemployment rate gap grows because older black workers lose their jobs faster than older white workers.

Discrimination in wages and employment persists in the U.S. economy beyond differences explained by white workers having more education than black workers. Blacks with a college education have the same unemployment rate as non college-educated whites.

Economic downturns and employment discrimination make it harder for older people to save for retirement. One solution to both unemployment and job discrimination is a federal job guarantee to ensure all citizens over 18 seeking employment have a job at non-poverty wages. Strengthening Social Security and creating Guaranteed Retirement Accounts (GRAs)- proposed universal individual accounts funded by employer and employee contributions and a refundable tax credit throughout a worker’s career - would help older workers, and older black workers in particular, off-ramp into an adequate retirement during a downturn.