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On Asset Liability Matching & Federal Deposit and Pension Insurance

On Asset Liability Matching & Federal Deposit and Pension Insurance. Zvi Bodie Federal Reserve Bank of St. Louis 30th Annual Economic Policy Conference FEDERAL CREDIT AND INSURANCE PROGRAMS Oct. 20-21, 2005. Outline. The current pension insurance mess

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On Asset Liability Matching & Federal Deposit and Pension Insurance

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  1. On Asset Liability Matching & Federal Deposit and Pension Insurance Zvi Bodie Federal Reserve Bank of St. Louis 30th Annual Economic Policy Conference FEDERAL CREDIT AND INSURANCE PROGRAMS Oct. 20-21, 2005

  2. Outline • The current pension insurance mess • Lessons of the S&L crisis: importance of matching. • Why did it happen to the PBGC? • Equities are risky even in the long run, and especially for the PBGC. • Investing in equities does not lower the ex ante cost of providing pension benefits. • What should the government do?

  3. Lessons of the S&L Crisis • Forbearance can make the problem worse. • Don’t adopt accounting rules that disguise the problem. • Diversification across asset classes can increase total risk exposure. • Hedging is more effective than diversifying in controlling specific risk exposures.

  4. How to manage credit guarantees • Mark collateral assets to market • Allow for buffer (Capital requirements, full funding with a “hair-cut”) • Right to seize collateral assets • Restrictions on assets that can serve as collateral • Charge market price for the guarantee

  5. Why were the principles not properly applied to pensions? • Fallacy about the risk of stocks in the long run misled investment advisers, pension actuaries, and regulators • Bad pension accounting rules created a disincentive to match assets to liabilities

  6. Implications for PBGC • Investment in equities and “alternative assets” increases the cost to the government of providing pension guarantees.

  7. What should the government do? • Congress should act quickly to limit the scale of the shortfall: • Reorganize pension plans of sponsors in distress. • Make reorganized plans a model for the pension industry. Best of DB and DC. • Create incentives for better matching in healthy plans. • Be an innovator in issuing new securities and let markets price them. • Examples: Long maturity bonds and TIPS

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