Monday, November 10, 2008

The Current Financial Crisis is only the Tip of a Long-Term Financial Iceberg!

With financial markets in crisis worldwide, policy makers are rightly focused on actions to restore confidence and enable banks to feel comfortable in renewed lending. Without such actions, the risk of a recession spiraling into a depression would be great. While households worry about their jobs and their portfolios, they also are recognizing that their long-run financial plans have now been jeopardized.

For years, analysts have warned that the U.S. government’s fiscal future is bleak—that its long-run obligations to retirees in the form of social security and, even more, for Medicare and Medicaid, have far outstripped projected tax revenues. Current policy actions to shore up the financial system have only added to the US government’s debt burden, making the restoration of long-run fiscal solvency even more difficult. Other potential liabilities loom, for example, if the US might be on the hook for bankrupt private, municipal, or state pension schemes. But the issues involved in addressing this looming fiscal crisis have long been the third rail of American politics. The focus of both Republicans and Democrats has, if anything, been more on enlarging health coverage than on restoring solvency to government obligations for medical care or social security.

The current financial crisis highlights that the private pillar of financial support for America’s aging population is now also severely shaken. Workers are starting to understand the risks associated with relying on high returns from home and equity investments for the financing of their retirement. Wealth in the form of home equity and 401K-type investment nest eggs has plummeted. The retirement plans of aging baby-boomers are being reconsidered. Pensioners who have relied on their investment portfolios to supplement social security, are worrying about whether they might need to reenter the labor market. Employers, including many states and municipalities, are worried that their pension plans are now seriously underfunded. And the prospect that households can rely on the Federal government’s promises with respect to medical and social security is even more threatened as the government’s own debt rises in the current financial crisis.

What must be done? First, we need to address the major weaknesses in America’s long-run growth prospects—an educational system that ranks far behind its competitor nations, failing and outmoded infrastructure, excessive energy dependence, and falling outlays on research and development. Without buoyant economic growth, the size of America’s pie will be inadequate to provide for rising living standards and a comfortable retirement for its citizens. Second, we need to fundamentally rethink how the financial costs of retirement are to be shared as between the baby boomers and succeeding generations. All serious analysts recognize that there are limits to what can be expected in the form of higher taxes on future workers. The sooner a fair and equitable sharing of the burden of Social Security, Medicare, and Medicaid is resolved, the lower the pain that any solution will entail. Third, increased wealth cannot be bought on the cheap by an expectation of rising home or stock equity values. Households will need to work longer, consume less, and save more. Finally, once the crisis is over, we must move to restore fiscal solvency. This means a return to a balancing of the Federal budget deficit over the cycle.

America could benefit by looking at the experience of other countries in Europe and Japan. They appear to be addressing the challenge of an aging population and providing comprehensive health care in a fiscally responsible way. Some countries in Europe particularly appear to have constructed social insurance systems and fiscal policy rules that are more responsive to these challenges than those of the United States.

As a first step, the next President should convene a nonpartisan commission to develop, within a tight timetable, proposals for energizing growth and restoring both fiscal solvency and a balanced role for the private and government sectors in financing the longer life span of America’s workers.

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