Bailout

Corporate optimism datapoint of the day

By Felix Salmon

Randall Forsyth reports on the magical math of corporate defined-benefit pension plans:

Fitch’s analysts find the mean assumed return for corporate pension plans in 2008 and 2009 was 8%. That’s with an allocation to fixed-income assets of 34% of the total.

Obviously, there’s no way that fixed-income assets can return 8% going forwards from here. There’s also little sign that pension plans are reducing their fixed-income exposure. And I can’t imagine that fund managers genuinely believe that long-term stock returns are going to be somewhere in the teens.

As a result, any intellectually honest plan is going to have to start cutting the interest rate it’s using to calculate the net present value of its future defined liabilities. And every percentage point by which they cut that discount rate means that the present value of their liabilities soars by between 10% and 20%. Cut by two or three percentage points, and suddenly all those cash-heavy corporate balance sheets start looking a lot lighter:

That’s the thing about deflation; it’s like a neutron bomb for corporate, public-sector and consumer balance sheets. Asset values and returns get decimated while liabilities remain standing.

There’s no news here, of course. Inflation is painful for the poor, but much easier for the rich, whose wealth is tied up in things like stocks and houses which tend to retain their real value. Deflation makes goods more affordable for the poor, but is horrible for anybody counting the days until their future liabilities come due.

Still, for the time being, I’m going to place my faith in the continued ability of corporations and pension-plan trustees to delude themselves about future returns and prudent current discount rates. The 8% return assumption didn’t make much sense in 2008 or 2009 either, and so the fact that it makes even less sense in 2010 is hardly a reason to think it’ll be reduced. It’s much easier for the current tranche of executives to leave this problem to their hapless successors.

Full post as published by Macroprudential on August 25, 2010 (boomark / email).