The Federal Reserve's low-interest-rate policy must end. The policy helped the economy recover from the depths of the Great Recession, but the economy is now strong enough to withstand higher rates.
While the low-interest-rate policy helped the wider economy recover, it harmed parts of it. Many observers have noted the impact of the low interest rates on savers, particularly those retirees who have much of their retirement savings in money market funds and bank savings accounts. Those retirees found their savings greatly reduced by daily living costs because of the ultralow interest paid on such accounts. Few have noted the impact of the low rates on defined benefit plans, and the companies and government entities that sponsor them. Low interest rates have greatly weakened pension plans and accelerated the trend away from them in the private sector.
The decline in rates since 2007 has pushed unfunded liabilities up, and the strong stock market recovery since 2009 has not been enough to bring liabilities down, even though companies and many state and local governments have contributed billions to their plans.
For example, according to the S&P Dow Jones Indices' annual survey of pension and other benefit obligations of the companies in the Standard & Poor's 500 index for 2016, corporate pension underfunding stood at $391 billion — 6.1% higher than 2015 — even though the companies contributed $52.5 billion to pension funds for 2016. They had expected to contribute $30.9 billion, but interest rate declines boosted the liabilities and made additional contributions necessary.
This volatility harms companies' ability to plan future investments and might be contributing to the slow growth in the nation's productivity.
The survey showed the industrial companies in the S&P 500 had $1.5 trillion in cash, which some might argue should allow them to fully fund their pension plans. But companies have other obligations for which they also must use that cash: interest payments on outstanding bonds; initiating long-term investments; and shareholder dividends and share buybacks.
Companies also need cash reserves against unforeseen crises. It's not surprising that cash reserves have risen since the recession, when companies failed after they ran out of cash and no institution was willing to lend. Corporate pension plan sponsors are caught between often conflicting responsibilities. Spending all, or even a good part, of their cash reserves to fund their pension obligations could put the interests of the pension beneficiaries ahead of shareholders.
Public employee plan sponsors face similar conflicts. They must manage the funds in the interests of both the beneficiaries and shareholders, that is, taxpayers. In too many cases, that conflict has been resolved in favor of the taxpayers as the plans have been underfunded through minimal contributions that avoided the need to raise taxes. Historically low interest rates have worsened the underfunding and highlighted how the plans and beneficiaries have been shortchanged.
These pressures on pension plan sponsors, private and public, could be greatly eased by higher interest rates. The Fed should wait no longer to push rates up.