Penalising the fat years could make all years lean
The pensions industry has joined the financial regulator in using hindsight to say we should have stored away more during the boom years. The snag is, that’s the time when there seems least need to do it.
The mantra of the it-mustn’t-happen-again brigade is that we must be countercyclical rather than procyclical. It’s going to be a hard concept to grasp however.
It’s not just the asset side of the equation that changes during booms, the liabilities change too. When companies prosper, for instance, they can afford to pay more into their pension schemes – as indeed can employees. But when companies prosper their shares rise and pension-fund assets increase, thus turning deficits into surpluses. High contributions would thus mean overfunding.
Yet when the companies’ fortunes turn down, fund deficits rise and sponsors need to contribute more when they can least afford it.
The Financial Services Authority chairman identified a similar problem in his recent report on banking supervision. When, say, house prices are rising banks can give large loans with little risk to their collateral because inflated values soon leave the mortgages well covered by assets. The banks thus need less capital backing for these loans.
In future the FSA proposes making the banks provide extra capital during the boom times, thus restricting the amount they can lend and their willingness to provide “riskier” loans, even when the risk is falling.
Now the Pension Protection Fund chairman admits it is considering increasing premiums by more than the rate of inflation in good times (when its services are least needed) and reducing them when times are tough (when claims are thus greatest). Unlike commercial insurance, the PPF is compulsory so will get away with it.
It makes good sense – so long as the regulators can spot fat years from lean ones.
During the last boom, when should the brakes have been applied? 1998? 2000? 2005? 2007? No doubt some people thought there could be another five years of boom to go and it wouldn’t be necessary to take action until 2010 or later. And when should they be eased: last year, now, next year?
The regulators risk putting out the fire before the room has heated up.
That, however, is their aim. Countercyclical policies merely cream off excesses in boom times to provide a reserve for recessions; procyclicality is designed to make the booms less high in the hope the downturns are less severe.
With hindsight it is an ideal policy, but it is hard enough predicting future cycles without trying to forecast the effects of interfering with those cycles. The danger is that procyclical policies kill the goose that lays the golden eggs.
