Kermit C. Zieg Jr.is a professor emeritus of finance and investments at the Florida Institute of Technology.
The Great Recession of 2008-09 nearly destroyed the world’s economies. The United States required drastic measures to regain stability, lower unemployment rates, save financial institutions, rally the stock market, inflate financial assets, restore consumer confidence and stimulate economic growth.
The major architect of the recovery of the past five years has been the Federal Reserve System. It embarked on a multifaceted approach to inflate assets and stimulate growth by forcing short-term interest rates to almost zero and drastically cutting long-term rates. And it worked: employment rose, banks became solvent and profitable, corporate earnings jumped and the stock market doubled. Homeowners en masse refinanced mortgages at much-reduced rates, saving thousands of dollars annually. Homeownership became much more affordable for first-time buyers. Stock market speculators made small fortunes. And business earnings jumped, thanks to lower borrowing costs.
Everyone seemed to win, but that’s not so. Retirees were badly hurt — devastated, in fact. They have not benefited from lower mortgage rates because their homes generally are paid off. They are not in the stock market because of the volatility. They primarily live on savings and the interest earned on these savings.
Ten years ago, a retiree could have earned $40,000 annually on $1 million of savings in a bank. Today, that same $1 million would be lucky to earn $5,000 yearly. If a retirement lifestyle was built on expectations of $40,000 in annual interest income and the reality today is $5,000, the improving economy has no relevance. Economic survival in a low-interest-rate market is the focus for retirees.
Do they have choices for increasing cash flows? Maybe. They can move bank savings into the stock market. The dividend income from a well-diversified portfolio of stocks, mutual funds or exchange-traded funds coupled with capital appreciation might increase yearly income. But the market is volatile, and there is a substantial risk of portfolio losses during any given time period.
Bonds are said to be “principal safe.” At maturity you recoup your original investment. And their yields are much higher than interest on bank accounts or brokerage money market accounts. A 30-year U.S. Treasury bond currently yields about 3.8 percent, or $38,000 annually per million invested. Sounds good, right? Not so fast. Most believe interest rates have bottomed — they certainly cannot go much lower. The probability is that rates are going to rise significantly in the years ahead. As interest rates increase, bonds drop in price. And the longer the maturity of the bond, the more its market value is affected by interest-rate changes. For example, a 3.8 percent yielding 30-year bond portfolio purchased for $1 million would decline to about $800,000 should rates rise to 5 percent. Sure, the retiree still earns the $38,000 annually. But if emergencies require early sale of bonds, there is a 20 percent loss on a “safe investment.”
I propose that the government create a new investment vehicle called “retirement bonds” exclusively for retirees that would provide liquidity, safety of principal and market interest rates. Since the government constantly borrows money to fund deficits, and part of this borrowing is from the sale of 30-year Treasury bonds, retirement bonds would combine the government’s need to borrow with retirees’ needs for income and safety of principal.
Specifically, these new bonds would have the following characteristics:
●Retirement bonds would be available for purchase only by individuals at or above the Social Security retirement age.
●They would have a yield equal to the interest rate on the most recently issued 30-year Treasury bond.
●Their interest rates would be reset quarterly to match the current yield to maturity interest rate of the longest-maturity 30-year Treasury bond. By resetting the rate on retirement bonds quarterly to match the longest-maturing bond, it would assure the retiree gets the highest possible Treasury bond interest return.
●The bonds could be redeemed at any time for full face value.
●Once redeemed, there would be a three-month waiting period before repurchase to prevent market timing speculation.
Retirement bonds would benefit both retirees and the government. The U.S. Treasury would have a new domestic funding source — i.e., one that doesn’t originate in China — that would grow over time as the pool of retirees swelled. As this pool swelled, the annual interest rate required for the United States to sell the bonds would drop, saving the Treasury significant amounts of money. And retirees, the group of Americans most damaged by today’s lower interest rates, would have a principal-safe, liquid product with a reasonable income stream that would stay market competitive.